"I can live with doubt and uncertainty and not knowing. I think it is much more interesting to live not knowing than to have answers that might be wrong" - Richard P. Feynman
While we have all been living with a greater feeling of uncertainty over the past year, looking at the world of pensions, uncertainty feels particularly relevant and long-term.
The recent Budget and subsequent tax consultation day were both preceded by numerous pension related rumours. The three main rumours were around the Lifetime Allowance, the system of tax relief on contributions, and the 25% tax free lump sum. Very few of these rumours became reality, but already we are seeing mention that these may well make an appearance in the autumn. The uncertainty is never-ending…
For those that this could impact personally, while we can’t provide certainty, there are a few key things to consider in relation to these three areas that could help protect your hard-earned wealth in the face of this uncertainty.
The Lifetime Allowance was the only pension topic actually mentioned in the Budget, with the current limit of £1,073,100 now scheduled to remain in place until 2026. This "stealth tax" will mean that more people are caught each year by this capped allowance as their fund grows or their salary driven benefits increase.
What can you do if you are impacted by this limit? The potentially obvious action is to crystallise your benefits sooner rather than later, in the expectation that this will mean a lower Lifetime Allowance value for your existing benefits. This may make sense in some situations. However, there are significant potential limitations or downfalls to this. In the first instance, this action is only open to those aged 55 or higher, with those younger still restricted in terms of access to their pension.
For those lucky enough to still be accruing additional benefit in a defined benefit (final salary) type scheme then it is extremely unlikely that leaving the scheme is sensible if this is purely being done to avoid a future Lifetime Allowance charge. As with most taxes, it is important to remember that the tax charge may consume a portion of additional benefits, but there is still a net benefit to accruing further pension rights.
For those with a money purchase or defined contribution pension, then there is more flexibility over the timing of taking benefits, and therefore the Lifetime Allowance test, but again there are significant implications of this. Funds withdrawn from the pension immediately become potentially liable to inheritance tax, and may also trigger the money purchase annual allowance and its restrictions on future pension contributions (most relevant where this may mean the loss of valuable employer contributions).
Tax relief on pension contributions
The tax relief system for pension contributions currently gives relief at an individual's marginal tax rate. The consequence of this is that the bulk of the cost to the Treasury of this relief is given to higher and additional rate tax payers. The often made argument is that the Government does not need to incentify these individuals to save (as they are highly unlikely to be financially dependent upon the state in retirement) and therefore this tax relief is misallocated in terms of incentives.
There are many in favour of a flat rate tax relief system, whereby the rate of tax relief on contributions is higher than the current basic rate level, but lower than that for higher rate and additional rate tax payers. For example, rates of 25% or 30% are often quoted. The major impediment to this is the defined benefit pension world, where the tax implications of a flat rate scheme would be hugely problematic.
Overall, particularly for higher rate and additional rate tax payers, the key point is, where relevant and attractive, to maximise current contributions in order to secure the current attractive rate of tax relief. This should include using the full annual allowance of up to £40,000 (but watching for the impact of the tapered annual allowance) and also looking at any unused allowance from the previous three tax years.
Tax free lump sum
Lastly, every Budget is preceded by speculation that the 25% tax free lump sum will be removed from pensions. This would have a clear and immediate tax benefit to the Treasury, but would be hugely retrospective. Millions of people have been saving into their pension for decades on the understanding and expectation that 25% will be available as a tax free lump sum for them at retirement.
To remove this now would create an unprecedented level of scepticism about future pension rights, and this could have a devastating effect on people's propensity to put money into a pension, particularly for younger workers who know that that money will be inaccessible to them for over 30 years.
Those though, who remain nervous about the potential for this change, can consider taking the tax free lump sum now (assuming they are 55 or older). However, there are many implications of this, particularly that the proceeds then will immediately become potentially liable to inheritance tax.
Living with uncertainty
So, pensions are rife with uncertainty, which is an unfortunate position for a long term savings vehicle that relies on confidence and understanding from those involved. As noted above, there are potential actions that could be taken, but in the vast majority of cases there are significant potential downsides to these and very careful and individual consideration needs to be made.
We don't have a crystal ball for which regulatory changes may occur in the future, but we can help you discuss the possibilities, the impact these would have on your financial planning, and the pros and cons of any actions that could be taken as a precaution against future change.
Given the scale of the government's recent pandemic related expenditure, then it seems that tax raising rumours are going to be ever-present. The uncertainty is, indeed, never-ending…
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