PensionsFeb 6 2023

Drop in older workers could lead to taxation on pensions

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Drop in older workers could lead to taxation on pensions
Surge in early retirement may have tax consequences to offset loss of skilled workforce. Photo by Marcus Aurelius via Pexels

The rise in people retiring at 50 and not returning to the workplace post-pandemic could result in higher taxation on pension pots and further rises in the state pension age, a senior economist has warned.

Ian Stewart, Deloitte's chief economist in the UK, analysed employment and immigration trends and warned that because "Britain’s labour has seen significant and unexpected change since 2020", there may be actions taken by government to make up for the loss of productivity.

He said: "The relatively high levels of personal wealth enjoyed by the over-50s could face increased levels of taxation and a further increase in the age at which the state pension becomes payable."

The pandemic has caused many people to re-evaluate their priorities.Ian Stewart, Deloitte

Stewart pointed to data from the Office for National Statistics, which has shown that three major factors are at work in the workforce: 

1) There has been a surge in the number of people retiring early, which has shrunk the workforce.

2) Increasing levels of migration from outside the EU have partially offset the ending of unskilled migration from the EU.

3) The pandemic has increased hybrid and home working, possibly by a factor of three.

Stewart explained: "More people are in work today than on the eve of the pandemic in most industrialised countries, though not in Britain. Its workforce has shrunk, mainly because of a rising number of people of working age withdrawing from the workforce."

Indeed, some 575,000 people have left work since the onset of the pandemic, equivalent to almost 2 per cent of the workforce.

While illness has played a part, with Covid-19 and delays in treatment on the NHS, fuelling levels of long-term sickness and disability, the majority of the leavers have been those taking early retirement. 

He said: "Retirement has surged among the 50- to 64-year-olds, most of whom own their own homes outright and have pensions and other savings. The pandemic has caused many people to re-evaluate their priorities and, for some, led them to opt for early retirement.

"In the UK, private pensions and the option to take 25 per cent of pensions as a tax-free lump sum provide more flexibility over the timing of retirement than in much of the rest of Europe where state provision plays a larger role."

Various opinion polls have suggested that most of these early retirees seem unlikely to return to work. Indeed, almost all the rise in inactivity is among people who say they do not plan to work again. 

However, he added: "Despite telling pollsters they are unlikely to return to work, some early retirees will find the lure of work, and the challenge, social connection and money that comes with it, irresistible."

Pension plans

Earlier this year, chancellor Jeremy Hunt set out his 'Four E’s for Economic Growth'. One of these focused on employment and the lack of older, skilled workers. 

This prompted reports that the chancellor was considering changing certain pension tax rules that might make it punitive for older workers to return to employment. 

According to Steven Cameron, pensions director at Aegon, the government could implement some positive tax changes that could encourage the over-55s to return to the workplace. 

Pension tax rules that need to be overhauled include the lifetime allowance.Steven Cameron, Aegon

He said: "With economic inactivity amongst over 50s worryingly high, we support any measures the Government can make to encourage this group to return to work. This would be positive not just for economic growth but for the finances of these individuals in their later life.

“As part of this, pension tax rules that need to be overhauled include the lifetime allowance, the annual allowance and the little known Money Purchase Annual Allowance."

The LTA has been frozen at £1.073mn in consecutive budgets, and will remain at this level until 2026. Commentators have warned that, with skyrocketing inflation, this means it is worth less each year.

Cameron explained: "More individuals who would not class themselves as wealthy are finding they have reached the limit. This is most likely if they have a generous final salary pension, which are now mainly in the public sector.

"It is one reason some highly paid doctors have left the workforce. We would like the Chancellor to make an immediate increase in the limit to £1.5mn and to reinstate inflation linked increases thereafter. This would remove the threat of tax penalties arising from further employment and added pension rights."

He would also like to see changes to the annual allowance, which limits pension contributions from the individual and their employer to £40,000 a year or earnings if less.

The chancellor wants to send a message to over 55s who have left the workforce that ‘your country needs you’.Steven Cameron, Aegon

Cameron explained that some individuals in defined benefit pensions may find the value of an extra year of pension benefit is valued at above this, particularly if they receive a significant pay increase for example on a promotion.

The government might allow more flexibility than currently exists before levying tax penalties.

And then there is the Money Purchase Annual Allowance, which might affect people over 55 who have started to take money from their pensions. 

Cameron said: "They may have done so because they have stopped work or to tide them over during the pandemic or the current cost of living crisis. Unfortunately, it means the most they and their employer can pay into a pension in future, including if they return to work, is just £4,000 a year.

"This means many are unable to take advantage of full pension entitlements and won’t be able to rebuild their pension pot for a later retirement. An increase to £10,000 would make it far less likely that individuals would be affected here."

Cameron added: "If the chancellor truly wants to send a message to over 55s who have left the workforce that ‘your country needs you’, then pensions tax rules need to be updated to reflect today’s world of work.

"While this might mean a little less tax is collected, it could generate much more if encouraging more employment participation.”

simoney.kyriakou@ft.com