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Government could lump savers with £4bn pensions tax raid

Former pensions minister Steve Webb has warned the government could still shift pension taxation to an ISA-style system, removing the tax-free lump sum.

Government could lump savers with £4bn pensions tax raid

Former minister Steve Webb has warned the tax-free lump sum could come under threat from chancellor George Osborne's reforms to pension taxation.

Writing in the Sunday Times, former pensions minister Webb said a move to ISA-style taxation of pensions could still be on the cards, meaning the £4 billion boost savers receive from the tax-free lump sum could go.

Under the current rules, savers are allowed to withdraw 25% of their pension untaxed when they hit age 55. However, that benefit would be a casualty of a move to an ISA-style system for pensions, where contributions are taxed but growth and income are free of tax.

Osborne announced plans to overhaul pensions tax relief in last year's summer Budget. Recent reports have suggested the government was backing away from an ISA-style system in favour of a flat rate of pension tax relief, which would see relief for higher earners cut.

But Webb said the chancellor's preference remained to move pensions towards ISA-style taxation. ‘I do not believe that the flat rate was ever the Treasury’s first preference,' he said.

'Back in July 2015 when the chancellor published his green paper, the idea of a flat rate was not mentioned at all. Instead, in his Budget speech, Osborne specifically floated an alternative idea, namely making saving for a pension more like saving in an ISA.

‘To the chancellor, the big attraction of the “pensions ISA” is that he suddenly gets a tax windfall. For all of today’s workers who would have been deferring tax on their earnings by putting their money into a pension, the tax has to be paid right now, as soon as it is earned…It is not hard to see why the chancellor floated this idea in the summer and why, I believe, his heart still makes him want to go down this route.’

Webb said cutting the at-retirement tax free lump sum would be ‘an extra tax bombshell’ that 'seems to have gone completely unnoticed’ in discussions of ISA-style tax treatment.

He said: ‘Successive chancellors have looked hard at doing something about the tax-free lump sum. In his 1985 budget speech, Lord Lawson famously referred to the “much-loved but anomalous” tax-free lump sum, ruling out touching it for fear of the political repercussions. But with a pensions ISA, this tax break quietly disappears.’

Webb said while getting rid of the tax free lump sums already built up ‘would be politically toxic’ , Osborne would be able to stop people building up any more tax-free lump sums on future pension savings.

‘Even for someone 10 years away from pension age, this could have a big impact on their retirement planning,’ he said.

14 comments so far. Why not have your say?

Jane Constable

Feb 22, 2016 at 13:18

excuse my ignorance but if this is correct then benefits arising from future contributions would be tax free in their entirety as per ISA funds. If he removed the tax free 25% in respect of existing funds whilst keeping the tax on withdrawal by ring fencing benefits accrued to date that would be political suicide, surely

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Anonymous 1 needed this 'off the record'

Feb 22, 2016 at 13:32

I am not totally anti the idea of a Pension ISA, but how does this compare with the recent reforms and "No change to public sector pensions for 25 years" (in which pension commencement lump sums are possible even if they are less attractive than previously)? ... or is my information out of date?

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Feb 22, 2016 at 14:04

If I am reading the proposed changes correctly, then any withdrawals from a SIPP will be tax free and so instead of receiving 25% tax free and your annual allowance, all draw downs will be tax free?

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Feb 22, 2016 at 14:09

Existing funds built up should be allowed to take 25% tax free at age 55 onwards. A level tax relief of say 30% and abolishing the fund size limit to 1m

would at least allow private sector workers to compete with public sector gold plated pensions which can often be worth well in excess of 1m.

The private sector pensions have to run the risk of investing in the stock market and are capped on growth ! Now that Osborne has throttled the buy to let investments private sector pensions have no other asset class to invest in.

Where is the encouragement for younger workers to provide for their retirement ?

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Christopher Roberts

Feb 22, 2016 at 14:17

This article does not make sense if you move to an ISA style savings then every withdrawal is tax free not just 25%!!!. He could switch at one point taxing input and freezing the 25% on the pension size at the time.

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Feb 22, 2016 at 14:30

Vestor > You have auto enrolment which forces people to save. Then you get rid of any incentive hoping that people are not savvy enough to notice the lack of incentive - then you make benefits means tested. That is the logical approach to get tax now and not later.

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Feb 22, 2016 at 14:50

The current system is E-E-T (tax Exempt input, tax Exempt growth and Taxed output), or more correctly (tax Exempt input, tax Exempt growth and Taxed 75% output, Tax free 25% lump sum).

The Pension ISA is T-E-E (Taxed input, tax Exempt growth and tax Exempt output)

The two drawbacks of T-E-E is having no tax to pay on output doesn't remotely compensate for the loss of compounded growth gained on the deferred tax or the fact tax is only repaid on 3/4 of the money taken back out.

There is the mooted buy two get one free bonus to try and help convince people to lock their cash away for 30+ years. However who trusts any Government enough to really believe you'd get it when the time came.

The 3rd option is R-E-T (Reduced taxed input, Exempt growth and Taxed output - with or without 25% tax free lump sum).

The drawback here is if the R & T are too far apart and particularly if there is no lump sum the whole exercise becomes pointless for high rate tax payers. Why risk locking your money away for 30 years for minimal gains (or worst still, a loss due to double taxation), might as well pay the tax now, take the money and run.

Either way any change is bad news, not least for the reason, what is going to be paying for the care home fees in 30+ years time if not the large pension pots of the retired.

Still Boy George isn't looking that far ahead - just to the next election, 30 years hence it will be a problem for somebody else.

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Feb 23, 2016 at 09:21

"move to an ISA-style system for pensions, where contributions are taxed but growth and income are free of tax."

ISAs are NOT tax free. The writer is forgetting that any tax credits on dividends are lost.

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william Westlake

Feb 23, 2016 at 10:07

Politicians are always eager to steal from the mouths of our children and grandchildren. An ISA pension is doing precisely that. Osborne says "I'll take the tax now, and you take the risk that my successors wont break the promise I'm making today and tax you again when you take out the money you've already paid the tax on." (Anyone who doesn't think they will be paying more tax on the same money to Osborne's son in thirty years is an optimist to the point of being a fool)

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Tony Stratfold

Feb 23, 2016 at 11:31

I can think of no larger disincentive to save for retirement other than to introduce a scheme whereby contributions are taxed as proposed in the ISA-style taxation of pensions. In a rapidly ageing population this seems to be a short-sighted proposal aimed at immediate tax income generation for the Treasury and ignoring the longer term consequences.

it is assumed that the "politically toxic" concept of getting rid of the tax free lump sums already accumulated, along with the legal challenges from those with contractual agreements confirming the right to withdraw 25% of their SIPP tax free, would not be contemplated. Or would it??

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Frank Frank

Feb 23, 2016 at 12:05

If he takes more money from the top 10%, more power to his elbow. Why not?

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Feb 23, 2016 at 12:53

Frank Frank - we are talking about personal pensions, not offshore funds, art, vintage cars, property empires and large family-owned companies.

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Dennis .

Feb 27, 2016 at 09:58

I agree with Jon, ISAs are a bit of a con and have become a marketing opportunity for the unwary. Building societies still advertise "tax free savings" as a selling ploy. In reality unless you are expecting to make gains of more than your annual CGT allowance there is little benefit in ISAs. Outfits like HL are even charging 0.45% management fee for assets in an ISA.

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Feb 27, 2016 at 18:48

Good point. For those who are short of time though, ISAs are useful in that income from investments held within an ISA don't need to be declared on a tax return.

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