Chancellor must cut the sky- high taxes on pensions
IT IS plain daft to believe that Lamborghini dealerships will be buzzing with the over- 55s this morning as they take advantage of their new- found freedom to cash in their pensions and blow the lot in one go.
Why should people who have spent 40 years responsibly building up savings for their retirement suddenly want to fritter it all on frivolities? The type of people inclined to spend their entire wealth on a Lamborghini are those who won’t have bothered paying into a personal pension.
Those withdrawing lump sums from their pension pots are far more likely to be motivated by a desire to invest the money elsewhere, to improve on the miserly rate of return being offered by their pension companies.
For years, holders of private pensions have suffered a crushing blow to their income. Annuity rates have been hit by record low interest rates and by quantitative easing – the Bank of England’s programme of printing money to push down bond yields. A 65- year- old retiring with a pension pot of £ 100,000 would be lucky to get an annuity paying £ 5,500 a year now, down from £ 8,000 in 2008.
Had public sector pensioners suffered such a fall in retirement income there would have been mass strikes on a scale that would have dwarfed the Winter of Discontent in 1979. But of course they have not suffered in the same way.
I have little sympathy, then, with opposition MPs who carp at the new freedoms granted to private pensioners while enjoying gold- plated pensions themselves. Yet there is one aspect of Chancellor George Osborne’s reforms that does deserve to be attacked: the way in which they treat pension pots for tax.
ANYONE taking a lump sum from their pension pot faces a huge shock when they receive their next pay packet. Under the rules, 25 per cent of any lump sum you take out of your pension will be tax- free. The other 75 per cent will be taxed at your highest rate.
Worse, Her Majesty’s Revenue and Customs ( HMRC) will treat the lump sum as if it were a salary rise. In other words, if you normally earn £ 2,000 a month and you decide to take £ 20,000 out of your pension fund to invest elsewhere the taxman will treat you as if you have suddenly had a tenfold pay increase – shunting you straight from the 20 per cent tax bracket and into the 45 per cent bracket.
It is possible to reclaim overpaid tax but it will take time and require you to fill in forms. Meanwhile the Exchequer will enjoy a loan at your expense.
An even nastier surprise awaits people who have succeeded in building pension pots worth more than £ 1million. Take out a lump sum when your fund is worth in excess of this sum and it will be taxed at a swingeing 55 per cent.
A million pounds might sound like a lot but it is not a huge amount when it comes to planning what could be a 30- year retirement. Invest the money in a FTSE 100 tracker fund and it would mean enjoying a precarious income of about £ 35,000 a year. Invest it in a much safer savings account and you would be lucky at present to derive an income of much more than £ 10,000 a year.
Just why are moderately-wealthy pensioners being subjected to the highest tax rate paid by anyone in Britain, 10 per cent above the income tax rate paid by billionaires?
And not only is it excessive, it is retrospective. People who have saved hard into their pensions for many years can have had no idea that one day their pension fund would grow to a level at which the Chancellor decided that a punitive tax would kick in.
The deviousness of imposing a retrospective tax will impact on younger people deciding how much to set aside for their retirement. By the time they retire will a future chancellor have decided to levy another punitive tax on pension pots worth more than, say, £ 500,000?
Pensions have become a bit of a trap. We are enticed in with generous tax relief. Then, when it is too late to do anything about it, we get hit. That is no way to encourage saving. Pen- sion rules should be determined with the aim of persuading as many people as possible to put enough aside as to be financially self- sufficient in old age.
How much easier it would be to encourage people to save if money taken out of pension funds, whether in regular or lump sums, was not taxed at all.
SHOULD that prove too expensive – and no one should forget the Government is still running a deficit of nearly £ 100billion – then the Chancellor should restrict the amount of tax relief given on pension contributions. The annual limit on contributions could be halved to £ 20,000 and the tax relief available to higher- rate taxpayers could be limited to 20 per cent. That would be better than hitting people with unexpected taxes later on.
In tapping pensioners for extra tax George Osborne has done the same as Gordon Brown, who used his first budget in 1997 to abolish tax credits on dividends on shares held in pension funds. It sounded innocuous, yet it now takes £ 10billion a year out of pension funds, making a huge difference to the growth in pension wealth.
The Chancellor has done us a favour in dropping the requirement for us to buy annuities, but if he wants truly to be on the side of pensioners he should drop his punitive tax too.
‘ Current system is devious and unhelpful’