The new tax rules were announced yesterday (21 July) in the government’s response to the pensions consultation.
They are designed to “ensure that individuals do not use the new flexibilities, which are intended to provide people with greater access to their retirement savings, to avoid tax on their current earnings by diverting their salary into their pension with tax relief, and then immediately withdrawing 25 per cent tax free”.
Those members who choose to draw down more than their tax-free lump sum of 25 per cent from a defined contribution pension will have their annual allowance slashed from the standard £40,000 to £10,000 per annum once it is chrystallised after the age of 55, the response said.
Once a member’s annual allowance is slashed to £10,000, it will remain at that level for the rest of their life.
Andrew Tully, pensions technical director at MGM Advantage said the new tax rules constituted “the least worst option on the table”.
According to Mr Tully, other government proposals discussed in meetings included a proposal to limit the tax-free cash on future contributions after someone had taken benefits.
He said: “So if you cashed-in benefits in April 2015, above tax-free cash levels, and kept paying more contributions you wouldn’t be eligible to receive tax-free cash on those contributions unless you waited for a certain period, for example 10 years.
“That would have been much more complex to explain, and build a system to cater for, than the reduced annual allowance.”
However, Mr Tully added: “It’s another system of change at a time when we are doing a lot of work [in terms of pensions at the moment].
“The literature will be complicated - what was one line of literature will turn into two paragraphs. We need to find a simple way of communicating to customers.”
Tom McPhail, head of pensions research at Hargreaves Lansdown, said he “couldn’t see any significant downsides” to the new rules, however he warned that as the changes take place, it will get more complicated from an administrative perspective.
He said: “On the face of it, this is an effective solution to what was potentially a tricky problem. We knew there was a problem and they [the government] appear to have found a solution.
“We always knew that in addressing this problem we knew that there would be more rules put into place. For financial advisers and pension providers the system just got a bit more complicated.”
However, Claire Trott, head of technical support at Talbot and Muir, warned that the new rules could create issues for providers because “£30,000 could be over someone’s annual allowance and it is not our responsibility to police it”.
She said: “If people have two different schemes with different providers, there is a much higher risk that they will pay in more than their annual allowance.”
“People may not realise that their annual allowance has dropped.
“The people most at risk are those already taking money from capped drawdown - from one pot - but they have another pot somewhere else.”
Ms Trott added that there were a number of benefits to the new system too, including the fact that “you can still have some contributions even after you’ve taken you benefits - whatever happens you get £10,000”.
