Abolishing the age 75 annuity requirement is great for the wealthy but irrelevant for mostMonday 13 December 2010
Abolishing the age 75 annuity requirement is great for the wealthy but irrelevant for most
Those with large pension funds will be able to take money out in cash if they wish
Increased flexibility is welcome, but the tax cut for wealthy over 75s is being financed by a tax increase on the less well-off who die early
- The Government's annuity proposals benefit the wealthiest enormously but at the potential expense of those lower down the income and wealth scale.
- Tax rates on pension funds passed on after age 75 will fall from 82% to maximum 55%, but those who die before age 75 face a tax increase from 35% to 55%
- The changes will help people who wish to stay in income drawdown beyond age 75, as they will not be forced to buy an annuity
- A 55% tax relief recovery charge is penal for those who received only basic rate tax relief and is far worse than the current 35% tax rate on drawdown
- These proposals will not help the vast majority for whom the pensions crisis and annuitisation problems are most damaging
- The reforms may worsen annuity rates, if more people annuitise early to secure their MIR and then take out cash in flexible drawdown, instead of waiting to age 75
- The reforms may encourage transfers out of final salary schemes if members with large pensions want to take out the value in cash
The Government's proposals for abolishing the requirement to annuitise by age 75 are fantastic for top earners, who will now be able to withdraw significant sums from their pensions. Those who have sufficient pension income to secure a £20,000 lifetime income (which would require over £250,000), will be able to take as much money as they like out of their pension fund, subject only to income tax rates - or if they are non-resident they can take the money tax free. The changes will also benefit people who want to remain in income drawdown arrangements after age 75, rather than having to buy an annuity.
These measures are irrelevant for the vast majority of pension savers. Average annuity purchasers have just £30,000. 450,000 people every year buy an annuity and less than 1% of those buying annuities have funds above £100,000, so less than 1% of these pension savers would have enough money to benefit from flexible drawdown. For the top few, however, the benefits are substantial. Not only will they be able to take money out of their pension funds, they also face substantial tax cuts from the current level of up to 82% tax on death for pension assets that have not been annuitised by age 75, down to a maximum of 55%
The tax cuts for the over 75s are financed by tax increases on drawdown.
Because of the parameters set by the Treasury for this reform, which stipulate that HMRC must not to lose any tax revenue, the less well off are being made to pay more tax, to offset this tax cut for the wealthiest. This is a transfer of wealth and tax benefits from the upper middle to the very top of the income distribution. The Government has decided to increase tax on unused pension funds on death, in order to finance the tax cut for the wealthiest over 75s. At the moment, the tax rate on pension funds left at death before age 75 is 35%. This tax rate is increasing from 35% to 55%. Yet these are likely to be people who have had to dip into their pension savings and could not afford to leave their pension funds untouched. They will, therefore, not be the very wealthiest pension savers. These middle class pension savers may see a large tax hike in order to allow a tax reduction for those who can afford not to use their pension funds at all because they have other sources of income to live on.
The following table is a summary of the changes proposed and shows the benefits in terms of lower tax and much greater flexibility for those who can afford not to annuitise or who have pension fund assets higher than needed to secure the Minimum Income Requirement. The Table also shows the tax increases for those in drawdown who die early.
|TABLE OF TAX RATES ON PENSION FUNDS ON DEATH|
Tax rate paid on death
Tax rate paid on death
Before age 75
After age 75
If no annuity bought
82% (70% tax and IHT)
Tax relief recovery charge unfair for basic rate taxpayers. Clearly, for anyone who only received basic rate tax relief on their pension savings, a potential 55% tax charge is draconian. It is called a 'tax relief recovery charge' but 55% will take away far more from their pension than was received in tax relief. The Government admits that perhaps a quarter of those affected may have received only basic rate relief on most of their pension savings. However, it has chosen to ignore this. Top rate tax relief gives £2 for every £3 people invest in a pension, which is a 66% benefit. However, those on basic rate relief get only 20p for every 80p they invest, a 25% uplift. Thus a 55% recovery charge is penal.
These changes may encourage transfers out of final salary pension schemes: Once the Minimum Income Requirement (MIR) has been secured, people will merely have to pay income tax on any money withdrawn from their pension fund. Having had top rate tax relief - worth an extra £2 for every £3 invested in a pension, there is significant tax arbitrage benefit in this new flexibility. This could, in fact, encourage more transfers out of final salary schemes, if top earners want to be able to take the cash out instead of having the pension income. The money can be passed on to heirs, with a maximum 55% tax charge on death, whereas a final salary pension will only continue being paid to a partner and, if there is no partner, it may simply cease being paid on death. So, in order to benefit from that money, people may decide to transfer out of their company schemes.
These changes may make annuity rates worse. The Government says these reforms are needed because the current rules are unnecessarily restrictive, however the removal of restrictions will only actually benefit the very wealthiest few percent of pension savers. Indeed, for many, the proposals could result in worse outcomes, if more wealthy people annuitise to secure the £20,000 annual Minimum Income Requirement (MIR) at younger ages. Someone in their late-fifties will now be allowed to take out their pension fund in one go at any time, as long as they have secured the MIR. Therefore, we could see many more people in their fifties and sixties buying annuities up to the MIR, in order to be able to access the money in their pensions. This would add to demand in the annuity markets and could lead to worse annuity rates for everyone else.
These reforms could help the pension tax regime to incentivise long-term care. For the wealthiest pension savers at least, once the MIR is met, residual savings can be taken out at any time to cover care needs. Perhaps we can build in some contingency for this in the legislation, allowing pension funds to be convertible into long-term care funding or insurance options, with tax incentives. This could help avert the looming care crisis, which will inevitably follow our pensions crisis as the ageing population reaches older ages. The Government says it will wait for the Dilnot Report into long-term care funding next Summer, before addressing this issue.
Notes to Editors: It is not clear why pension funds passed on without income ever being drawn are inherited tax free: Current pension taxation policy seems illogical (see table). The Government stresses that tax policy is supposed to ensure pension savings are used to provide an income in retirement and that the tax relief is recovered later - also that pensions should not be a means of passing on wealth tax free. However, the current tax regime on death for those who have not yet started drawing an income neither provides income nor recovers the tax relief, which goes against the stated principles and rationale of the pension tax relief regime. In fact, as long as an income has NOT been taken from the pension fund, it is passed on tax free on death. This means that those who are wealthiest and can afford not to take any income from their pension, can pass on their accumulated pension savings tax free if they die before age 75, while those who need to take some income will suffer a tax increase from 35% to 55%. If the aim of tax relief is to ensure people have an income in retirement, then surely the tax relief recovery should be made from those who have not actually taken any income. Now would be an ideal opportunity to reform pension taxation fairly, rather than merely improving the position of the top echelons of society at the expense, potentially, of those lower down.
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