What could be more engaging than the concepts of CASH (always something to be interested in) and TAX FREE (conjures up ideas of Monaco, Cayman Islands or the duty free shop at Newcastle International depending upon how your cloth is cut). In this article Andrew Weaver looks at the tax free cash entitlement at retirement.
Many consider the tax-free lump sum to be the most beloved of our pension scheme benefits. It releases benefits from what is otherwise a rigid non-flexible savings plan in the form of spendable cash without creating a tax charge.
Who could want for more? Well maybe this benefit has become a little too attractive. Pensions in the UK have, up to now, been a carrot and stick sort of arrangement. The carrot being tax relief on contributions and the beloved tax free cash. The stick being the inability to get your hands on your benefits until age 55 and then, for most of the pot, only in pension income form.
In his budget speech, George Osborne significantly reduced the impact of the stick by putting forward proposals that would allow individuals over age 55 to have free access to all of their pension pot (please note this added flexibility will not apply to “final salary” type benefits). This is a very significant development
At this stage, the concepts of proportion and relativity enter the argument and it is now being debated that if the stick is not so scary then the carrot no longer needs to be so enticing.
So in the interest of prudential fiscal policy some are now questioning the need to entice people into pension saving by offering a juicy tax free cash payment at retirement. For example:
“Proposal 4: The 25% tax free lump sum should be scrapped, with accrued rights protected”.
Retirement Savings Incentives: Michael Johnson: April 2014, Centre for Policy Studies (a Think Tank closely aligned to the Conservative Party).
“This paper proposes that those individuals taking lump sums above the higher rate tax threshold (£42,475) should have to pay tax analogous to tax at the higher rate”.
A Relief for Some: Mark Lloyd, Chris Nicholson: November 2011. Centre forum (a Liberal Democrat Think Tank).
“An alternative approach would be to cap the size of lump sums that are available tax free. For example a cap of £36,000 would mean 75% of current lump sums would be unaffected but the largest 25% of lump sums would be capped”.
Pensions Policy Institute: Tax Relief for Pension Saving in the UK. July 2013.
Amongst think tanks, there is a growing momentum to question the efficacy of continuing to allow tax free lump sums as a benefit of an already tax advantaged pension scheme. From a political point of view it is hard to envisage the removal of tax free cash in advance of the May 2015 election. Too many votes may be in jeopardy.
My own view is that tax free cash will not change before the next election and if it does, it is likely that entitlements to existing lump sums would be protected by some “grandfathering” rules allowing current levels of tax free cash to be maintained. But there is no certainty here and it makes for an interesting wager.
- Chances of losing the tax free cash entitlement => Low probability
- Cost of loss => High stake
So where does this leave people who are yet to release their lump sums? You might take the view that, because of the low risk of change, you should decide to sit on your hands and do nothing for the time being. Alternatively, you may be alarmed by the prospect, albeit small, of losing out on the very significant tax saving and decide to release benefits now.
If you are over 55 you should perhaps at least be considering releasing tax free cash, as long as it does not compromise any other financial plan. It is now possible to release tax free cash without having to release any pension income. Releasing tax free cash can, therefore, often be done without having to make the bigger decisions such as whether to buy an annuity, including spouse’s pension etc. If there is a little downside to releasing tax free cash why not enjoy the certainty of having had your tax free benefit without having to worry about the (albeit unlikely) risk of it being removed or restricted in the future.
If you wish to discuss the pros and cons of releasing benefits, or wish to have more detail on the new proposals on the flexible release of benefits, please do get in touch.