It is important for consumers to understand the tax effects of withdrawals, according to Linda Ennis, technical officer at the Low Income Tax Reform Group.
Following the implementation of the pension freedoms, savers have four core options to take income, which include buying an annuity, taking the whole pot as a cash lump sum, ad hoc lump sums without crystallising the pot, or new flexi-access drawdown.
A maximum of 25 per cent of a pension can be taken tax-free, however, the remaining 75 per cent will be taxed at the saver’s usual rate of income tax.
Speaking during FTAdviser’s On Air Live debate on the at-retirement reforms, Ms Ennis flagged up the importance of people understanding the impact that making a withdrawal is going to have.
“Whether you take it as one lump altogether, or whether you take withdrawals over several years, can affect the total tax you pay on a payment in its entirety.”
David Trenner, technical director at Intelligent Pensions, said generally most of his firm’s clients are a little bit more comfortable and a little bit better planned when it comes to accessing their pension pots. “This hasn’t come as a ‘wow, let’s go for it sort of thing’,” he commented.
“We do have people coming in and saying ‘we’ve got a policy for X, Y and Z and they won’t let me do anything’ and I take the view that while insurance companies are often their own worst enemies in this particular scenario, the worst enemy was actually a chancellor who was determined to get a scoop, didn’t let anyone know what he was thinking and then said to insurance companies you’ve got contracts which you’ve written.”
In response to a question about whether the rules on how flexible access to pensions impacts welfare benefits, Ms Ennis said: “No I don’t think they are clear enough, there are issues over how it affects the benefits and also whether it is taken as a capital or revenue amount.”
However, all this may change as the government is looking to reform the pensions tax system.
Following the summer Budget, the government published a green paper which suggested a fundamental reform of the tax system is needed, suggesting that pension contributions could be taxed upfront, rather than on withdrawals; in a ‘taxed-exempt-exempt’ system like Isas.
The government said this may allow individuals to better understand the benefits of contributing to their pension as the state contribution might be more transparent.
However, many industry experts have come out against this, with warning that pensions taxation changes alone will not solve the UK’s £9,000bn retirement savings gap, and the government needs to focus more on auto-enrolment to encourage higher levels of contributions.
Steven Cameron, regulatory strategy director of Aegon, previously said that while the Pension Isa may look simpler to brand new savers and would save the chancellor money in the short term, in every other respect, it would be “highly damaging” to UK pensions, placing huge burdens on future generations of workers to support a growing retired population.
“The Pension Isa would be fundamentally incompatible with the current regime. Everyone already saving into a pension would have to stop paying into their existing scheme and set up a brand new one.”
The Association of British Insurers also suggested that a new upfront government ‘savers bonus’, based on a single rate of tax relief, should replace the existing complex pension tax relief arrangements. This bonus would top up payments made into a pension at a rate of £1 for every £2 or £3 put in.
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ruth.gillbe@ft.com
