Warning sounded on 'disastrous' pension tax proposal

Warning sounded on 'disastrous' pension tax proposal

The industry has heavily criticised proposals made by a think tank to scrap pensions tax-free cash and fund the abolition of inheritance tax instead.

Mark Littlewood, director-general of the Institute of Economic Affairs, called on the government to make the tax change in an article in The Times, where he argued “there is very little to justify the tax-free lump sum people can withdraw from their pension pot”.

But providers and advisers have warned of "potentially disastrous long-term consequences" from any such measure, which they said was a far cry from "progressive change".

Under the pension freedoms reforms most pension savers over the age of 55 are entitled to take some or all of their pension savings in the form of a cash lump sum, with the first 25 per cent being tax-free.

Mr Littlewood noted that putting an end to that carve out could, for example, go alongside reducing or eliminating inheritance tax.

He added: “In very broad terms, the burdens and benefits are both felt by the same demographic. Simplifying the tax system should involve taking rather less with one hand, while giving out less with the other.”

The Institute of Economic Affairs is a right wing think tank that has previously called for IHT to be scrapped under a "radically reformed tax system".

It emerged last week that chancellor Sajid Javid is considering to either scrap or make reforms to the unpopular inheritance tax regime later this year.

Tom Selby, senior analyst at AJ Bell, warned “able to access a quarter of your pension pot tax-free from age 55 is one of the best understood benefits of saving in a pension, so ditching it altogether would have potentially disastrous long-term consequences”.

He added: “Rising average life expectancy, the increasing state pension age, and the disappearance of guaranteed defined benefit provision is placing ever greater onus on individuals to provide for their own retirements.

“Given this context, public policy needs to be focused squarely on ensuring the environment encourages more pension saving, rather than pulling the rug from under people.”

Mr Selby also noted there would be “severe practical issues” in imposing such a measure.

He said: “Those who had saved money on the assumption they would get 25 per cent of their final fund tax-free would justifiably feel aggrieved at an essentially retrospective tax grab.

“Even introducing a cap on tax-free cash would create a severe cliff-edge, so it is likely complex transitional measures would be needed."

Paul Gibson, managing director at Granite Financial Planning, noted the withdrawal of tax free cash had been talked about since he entered the profession over 20 years ago.

He said: “Removing it would probably be the stupidest thing a politician could do, as it would negatively impact everyone, and may be the trigger for many to give up on pensions altogether.”

Steve Webb, director of policy at Royal London, said: "Whereas few people understand the benefits of marginal rate tax relief on pension contributions, pretty much everyone is aware of the tax-free lump sum.