Pension tax allowances have created a complicated system that is not working in the interests of consumers
Being able to get tax relief on contributions to a pension scheme is probably something that we tend to take for granted and don’t value enough.
The relief provides an incentive to join a pension scheme in preference to other types of investments and, without it, our pension pots and overall income in retirement would be considerably lower than they are in consequence.
But this all comes at a cost to the taxpayer – at the last count £24bn for individuals and another £17bn for employers’ contributions – and it is entirely right that the government places limits on the maximum amounts any one person can receive by way of tax relief.
These limits – or allowances, as they are referred to these days – have their origins in the big “simplification” exercise in 2006, when the notion of having both an annual allowance and a lifetime allowance came into force.
Unfortunately, since then, things have hardly stood still. The levels of both allowances being adjusted with bewildering rapidity to the point where savers don’t know where they stand from one year to the next, or how much they can safely put into their pension without incurring a hefty tax penalty.
What allowances do we need?
Now that the annual allowance has been reduced from its peak of £255,000 to £40,000 and the lifetime allowance from £1.8m to £1.03m (rising to £1.055m from 6 April 2019), do we need both?
The existence of the LTA is also challenged by many, given the depressing effect it has on saving, allegedly causing many doctors and other professional workers to prematurely retire from work. Such individuals would benefit from taking good advice as it is possible that they might be giving up valuable benefits just to reduce tax.
The government has compounded the problem by adding two new fairly obscure allowances into the mix – the tapered annual allowance for high earners and the money purchase annual allowance.
Also, other than a minority of experts in this field, does anyone understand the concepts of mandatory and voluntary scheme pays and the different deadlines for election for scheme pays and payment of annual allowance tax to HM Revenue & Customs? And what about the MPAA?
According to recent figures from HMRC, the number of individual pension freedom payments hit a record 628,000 in the final quarter of last year. That, in itself, is not necessarily a bad thing – yet you do wonder just how many of the thousands of over-55s who are dipping into their pension pots while continuing to benefit from workplace pension contributions are at risk of a shock tax charge.
A simpler system
Many will be totally oblivious to the fact that by even withdrawing a very small amount from their pension pot that would be subject to income tax – for example, perhaps for a holiday – they could inadvertently be triggering the MPAA.
This means they are effectively restricting the total that can be paid into their defined contribution pension plan without a tax penalty for every year from then on to £4,000. This is a big drop from the £40,000 that would otherwise be allowed – all that means for their future retirement plans and level of pension income in retirement.
There needs to be a comprehensive review of all these allowances. Do we need all of them? Would one smaller annual allowance not suffice? What damage are they inflicting on people’s retirement plans? Is there not a better way?
Assuming at some stage the government can lift its mind from Brexit, I would urge it to look at a system which is not working in the interests of consumers and needs to be sorted as soon as possible.
Malcolm McLean is senior consultant at Barnett Waddingham