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Osborne launches 'stealth' pension tax relief reform

Pension experts believe the chancellor is pushing through tax relief changes through the 'back door' with the new Lifetime ISA. 

 
Osborne launches 'stealth' pension tax relief reform

Chancellor George Osborne's creation of the Lifetime ISA represents a 'stealth' measure to reform tax relief on pension contributions, according to experts.

Before the Budget Osborne was expected to overhaul the system of tax relief on pension contributions, which is expensive and seen as benefiting the better off.

Reports suggested he favoured either a flat-rate of tax relief or a system which taxed contributions like ISAs, so that savers receive relief when they make a withdrawal rather than when they make the contribution.

Although Osborne did not announce any changes to pension tax relief in the Budget, experts said the introduction of a Lifetime ISA in the Budget was nonetheless a move to change the system.

The new ISA will be available to people under 40 from April 2017. For every £4 saved into a Lifetime ISA, the government will add £1.

Martin Tilley, director of technical services at Dentons, a provider of self-invested personal pesnions (Sipps), said the chancellor saw Lifetime ISAs as a ‘stealth’ measure to introduce tax relief reform.

'It's a stealth introduction, which may be phased in over time, of Pensions ISA,’ he said.

'It's all very well the chancellor saying there will be no big changes to pension tax relief at the moment, but I think actually he's slipped in through the back door a means of introducing it at a later date, without as much of a fanfare.'

Darren Philip, director at B&CE, a workplace pension provider, agreed the policy represented the introduction of Pension ISAs ‘by the back door’.

'Obviously the government had to shy away from its wider tax relief reform for whatever reason, but I think that will very much still be on the agenda, and it will be revisited,' he said.

Former pensions minister Steve Webb described the Lifetime ISA as a ‘Trojan Horse’ for pension tax relief changes.

Webb, who is now director of policy at Royal London, the mutual pension and investments group, said he was still concerned that people would not trust future governments not to tax withdrawals.

'It could be a Trojan Horse for the Pensions ISA. If it was it would be subject to all the problems in thirty years' time of trusting chancellors to honour the promise,’ he said.

Pushed into pensions

Tilley said the Lifetime ISA could become part of the pension regime, falling under the £40,000 annual allowance for pension contributions.

‘Your annual allowance for pensions will be £40,000, but you have to deduct from it any payment you make into your Lifetime ISA. It could be the beginning of the end of the current regime as we know it, albeit something that takes place over the next 30 to 40 years,' he said.

Claire Trott, director at Sipp provider Talbot and Muir, pointed out people who wanted to withdraw savings before they turned 60 faced a large exit penalty.

'You can use the funds at any time to buy your first home, however if you want to withdraw the funds at any time before you're 60, the government will reclaim their bonus, and there's a 5% charge as well, including any growth,' she said.

9 comments so far. Why not have your say?

PaulSh

Mar 17, 2016 at 15:28

All the chancellor needs to do now is to announce the "soft closure" of all existing private pension arrangements and switch all auto-enrolled pension contributions into LISAs with the ability to transfer people's existing pots to them. Everything then becomes very simple, and the tax relief, salary sacrifice and lifetime allowance questions are resolved at a stroke with the added benefit of pulling the tax revenue from pensions forwards 40 years. It's a brilliant win-win for the government. So brilliant you can tell somebody else thought of it.

Further down the road, pensioners in the existing closed schemes can be brought back into making NI contributions in the name of "intergenerational fairness", and even further, the "tax-free" income from LISAs can start to be taxed. Another win-win.

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Keith Cobby

Mar 17, 2016 at 15:49

I think the next step is to remove higher rate tax relief and then pensions/LISAs will attract a flat rate of 25%.

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dlp6666

Mar 17, 2016 at 15:51

And I'm sure the tax-free lump sum will soon be whittled down to zero.

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PaulSh

Mar 17, 2016 at 17:44

@Keith Cobby, surely the whole point of the LISA is that once it's in place it allows the government to make radical changes rather than just tinkering with the existing system. They can simply just close existing private pension arrangements to new members under 40 and transfer all auto-enrolled pensions of people under 40 to a LISA. This would have the effect of removing higher rate relief, with the additional benefit for the government that the savings bonus which replaces standard rate relief stops at age 50.

Once this has all been done, because there is no more tax relief on pension contributions, income tax and National Insurance can be merged. This saves vast amounts of government administration costs, but also increases taxes on pensioners drawing money from the old-style arrangements. Which, I'm sure they'll be told, is only fair because they got more tax relief than younger people with LISAs.

@dlp6666, again I can't see the point of tinkering when you have a radical alternative. Removing the tax free lump sum will badly affect many people if not done extremely gradually. Not to mention bankrupting the UK cruise industry!

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Jon

Mar 17, 2016 at 18:28

Not so easy as Osborne would have to deal with employer contributions too. And company / public pension funds would become a greater inequality

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Gareth Harries

Mar 18, 2016 at 01:20

At last people are waking up to the effect of introducing this scheme. My initial reaction to this was that it was a backdoor method to introduce changes to the existing pension schemes, as most of the other benefits of the proposed scheme were in effect negligible and not a good use of Public Funds.

I come from a generation of: If you defer income until a later stage on in life then you should only be subject to Income tax etc. at that point in time; but it appears that rationale has long been lost in to to the mists of time!

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horshamtim

Mar 19, 2016 at 12:57

I am with PaulSh on this. It is an astute move which keeps several options open. Contributions into a LISA will sidestep the issue of playing around with tax relief which is more complicated than it sounds in terms of payroll administration. It also potentially allows tax relief for money which has not been received as earned income, such as inheritance. The soft closure could just be for the under '40s so that as this group get older LISAs will be the only option. This manoeuvre over time will also remove the 25% tax free lump sum without affecting all those who are now coming up to pension age.

Merging tax and NI will mean a lot of savings and would make the overall tax system much simpler and fairer. It is difficult to justify older richer pensioners having a lower tax rate than those in work. The current funding model for state pensions is unsustainable, and the budget reductions in NI for the self employed won't help. With the declining ratio of workers to pensioners sooner or later a government will have to tackle this, but I don't expect this to happen anytime soon.

Gareth - one of the negatives of the pension freedoms already introduced is that we are seeing people who only ever got 20% tax relief now paying 40% tax by taking out their pensions as lump sums. Indeed previous budget papers assumed a nice flow of extra tax from this source! The equation only ever made sense if your tax rate reduced on retirement. For everyone else LISAs will be better and simpler - provided they remain tax free at the end!

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Mr J

Mar 20, 2016 at 00:12

Apparently the laws of politics mean:

No government will ever actually cut government spending.

Governments will constantly look for more money that they can forcefully take from the people.

Pensions are nice large pots of money some people have diligently saved for their old age. Therefore governments will rob pensions again and again and again until there is nothing left.

They will even rob pensions so they can use the money for "tax cuts" to make them more popular.

No government will ever again put a penny in income tax. Why be honest, open and direct when you can be dishonest, concealing, and obtuse.

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Gareth Harries

Mar 23, 2016 at 00:15

horshamtim

There is no need for people to pay a 40% tax rate on their withdrawal from their pension. All it takes is a bit of simple tax planning to make sure that you avoid the 40% tax rate! So I can't agree it is a negative of the Pension Freedom. As to the case of it only making sense if your tax rate reduced at retirement, I don't think that is quite true as the tax free lump sum would have also accrued tax relief and it is quite possible depending upon growth rates etc. to have received back all your contributions as a tax free lump sum

So far I have not found any negatives, only choices and freedoms. If people want to maintain the Status Quo and take their tax free lump sum and then take an annuity they are perfectly at liberty to do so. If you want to take it all and suffer the tax consequences you have the choice to do so, but not what I would recommend. Between these 2 extremes there are plenty of options available.

Which I have exercised for this tax year. I still do a bit of occasional consultancy, so wanted to withdraw all my dividends from my company before the new tax rules from the next tax year, so slowed the withdrawals from my pension scheme.

Before the new freedoms, it would have been a bit more complicated to do so due to the restrictions on withdrawals under the previous system might have meant I would have to have taken the extra income from my pension over 2 years, but I won't have to do that this time.

As to a LISA, higher rate taxpayers quite clearly lose out (so not better for everyone and you will not be able to take it out until you are 60) if this becomes the norm for pension savings, but standard rate taxpayers clearly gain by the extra tax relief.

However, I have always operated on the principle that I do not trust any government; one minute something is in and the next something is out; I would not trust another government (Nanny state) especially a Labour one (given their reactions to the original pension freedoms), that likes to tell people what they can and can not do, to bring in rules that prevent people exercising their choice and changing the tax rules as you withdraw; but I have no crystal ball, but will base my views on how I have seen governments work in the past!

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