Last March chancellor George Osborne promised pensions savers the earth. He is now realising it is impossible to deliver the freedom for retirees outlined in his budget speech without taking something away – unless, of course, he is happy to lose around £20bn a year in tax revenue.
Osborne’s budget for savers was hailed as a political masterstroke – getting rid of the need to buy annuities, treating pensioners like adults when it comes to spending their pension pots and, fundamentally, suddenly making pensions popular again.
What the Treasury bods haven’t seemed to have fully thought through, however, is how to bring in this promised freedom without opening the floodgates to mass tax avoidance. The problem is, pensions are just too generous
For decades the deal on private pensions between state and individual was about rewarding people for saving for the long term – you get loads of tax relief on pension contributions because you have to tie up your money until you are 55 and then take it a bit of a time for the rest of your life. Without tax relief, why else would you chuck your hard-earned cash into a safe that you haven’t got the key to, and that only gives it you back at a trickle.
From next April the Chancellor wants pensions to be treated like a current account, once you’ve celebrated your 55th birthday. It’s your money, spend it as you wish. There is even talk of pension providers offering customers ATM cards so they can make withdrawals from their pension pot from a hole-in-the-wall.
The problem is, if pension is so easily accessible to the over-55s, why pay them anything else? If you are over 55, why not ask your boss to pay you in pension rather than salary? If you do, the savings are massive.
I am not sure the Treasury had twigged just how massive when they put the budget speech together. Pay someone salary and the employer has to pay National Insurance of 13.8 per cent on everything over £7,956, with the employee paying 12 per cent NI on that sum too. And then income tax is payable on 100 per cent of earnings, once personal allowances are taken into account.
Get paid in pension and there is no NI paid by either the employer or employee, and you get a quarter of your cash tax-free.
For someone on £40,000 a year paid entirely as salary, tax and NI paid by the individual is £9,845.28, with a further £4,422 NI paid by his or her boss.
Pay them the minimum wage of £11,484 and the balance as pension, a process known as ‘salary sacrifice’, and the tax paid is £4,997. Because over-55s are to have full access to their pension to use as they wish, they will be able to simply use their pension pot to pay their weekly expenses, rather than their current account.
If everyone over 55 were paid in this way, the Treasury would lose around £20bn a year, which is clearly not going to happen.
So what is going to happen? From what I hear Treasury officials are still going round in circles trying to figure out which restrictions on pension savings they can introduce will upset the least number of people.
What is clear is that you will lose some of the privileges of pensions saving if you take any money out. So anyone who draws cash from their pension could find they will not be entitled to tax-free cash on contributions they make after doing so.
We could also see National Insurance introduced on pensions contributions, although that would hardly go down well in an election year.
Or, once you have pulled out some cash, we might see the amount you are allowed to pay into a pension shrink from £40,000 to, perhaps, £5,000 a year. Or we could see complex rules saying you cannot change the way you are paid once you hit 55.
For the people who have planned to use their pensions to clear their mortgage or pay for children’s education fees, these restrictions will not be welcome, as once they have taken cash, pensions will be less attractive. But then pensions are meant to be for later life funding, not mid-life spending.
Penalising people who dip into their pension will be more problematic for that growing army of older workers who the Government is encouraging to move into retirement gradually, by working part time and drawing on some, but not all of their pension.
Don’t get me wrong, I think it is great people will be able to spend their pension fund in the way that is most suitable for them. But we should be under no illusions that the hugely generous tax structure that is enjoyed today will be there to fund them.