Our pension tax system has long been characterised as needlessly complex, increasingly contributing to counter-productive outcomes in terms of working patterns and investor behaviour.
Doctors contemplating returning to the workforce are hearing horror stories from colleagues who have been hit by large tax bills they do not understand and had no way of expecting.
Savers with large pension pots change their savings behaviours when they approach the lifetime allowance (LTA) limits – why take a risk and suffer 100 per cent of the loss if things go badly when you will only get 45 per cent of the upside if things go well?
The abolishment of the LTA will greatly simplify the explanation of tax relief to the customers of financial advisers and pension providers. It will also greatly simplify the costly and complex series of reporting between pension providers and HMRC that is required in order to keep track of all of this.
It all depends on how successful the government is in persuading older workers to commit to working for longer.Time and money at HMRC could be better spent on developing a pensions solution for the self-employed.
In terms of the customer impact, many older workers who had left a workplace pension or ceased contributing to a personal pension/self-invested personal pension will once again be able to contribute. Those who are in employment may be best advised to do so through their employer’s scheme, given the matching contributions.
A slight sting in the tail is the capping of tax-free cash (TFC) at its current monetary amount (£268,000). This means that over time the value of TFC will fall in real terms, and as pension pots grow in size, TFC expressed as a percentage will reduce. Someone whose pot grows to £2.5mn will only be able to access around 10 per cent on a tax-free basis.
This could actually be a real win-win for both pension savers and the exchequer. If people spend longer in full employment, they will pay more income tax during those years than if they had retired.
By delaying retirement, they will accumulate a larger pension pot and benefit from a higher annuity rate, meaning that they will then go on to have a much larger pension income, on which they will pay more tax, potentially at a higher rate.
This could actually be a real win-win for both pension savers and the exchequer.It all depends on how successful the government is in persuading older, highly skilled and highly paid workers to commit to working for longer.
There was also a change to the annual allowance), which has increased by 50 per cent to £60,000. It appears that this is primarily aimed at preventing public sector workers in defined benefit schemes from being hit by those unexpected tax bills.
However, it is also a big benefit for DC savers. For those using wraps, the typical split of an annual £100,000 investment would have been £40,000 pension, £20,000 Isa, £40,000 general investment account. This will now more typically be £60,000, £20,000, £20,000 respectively.
There has also been a welcome reform to the money purchase annual allowance (MPAA). This was introduced to counter-balance George Osborne’s pension freedoms, to prevent very wealthy pension savers from recycling money through the pension system to benefit from the preferential tax treatment twice.
However, we have seen through the pandemic and then the cost of living crisis that less wealthy people were taking out small amounts from their pension just to make ends meet.
As we hopefully emerge from all of that, those who want to rebuild some of those diminished pension pots should be allowed to do so. The increase in the MPAA from £4,000 to £10,000 will help there.
These are reforms that we have advocated for quite some time.The combination of the change to tapering and the new AA means that tapering will now kick in on a salary of £260,000, up from £240,000. Because the tapering is now a £50,000 drop from £60,000 to £10,000 AA, workers will see their AA reduce by £1 for every £2 earned between £260,000 and £360,000.
These are reforms that we have advocated for quite some time. Financial advisers continually told us about the complexities in explaining the tax treatment of pensions to their clients and the unwelcome side effects. We are delighted the government has responded so emphatically.
Financial advisers now need to identify those clients who can benefit from the new limits, but may also want to work with some clients to re-examine their investment strategy where they have been close to the LTA, now that the risk/rewards ratio has changed.
This change is attracting a lot of commentary across the political divide. One of the consequences of this radical announcement could be the trigger point for a more fundamental reform of pension tax relief, which I think all of the main political parties have thought was necessary, but none of which had the appetite to address.
For me, the areas with the highest potential for change in the future, now that TFC has been capped, is the tax treatment of pensions on death, and potentially a move to a flat rate of tax relief at either 25 per cent or 30 per cent depending on the state of the nation’s finances more generally.
Pete Glancy is head of policy at Scottish Widows
