Could we really see the end of the tax-free lump sum?
George Osborne is rumoured to be planning a raid on the tax-free lump sum perk enjoyed by pensioners.
Savers already facing up to the prospect of the principle of tax-free pension saving being hacked back by the removal of full higher rate tax relief have been warned that the much prized tax-free lump sum is also be under threat, if a full on revamp to an Isa system arrives.
This would hit a chunk of pension saving that is taxed neither on the way in, or way out.
What is the tax-free lump sum?
Currently, whenever someone comes to retire and takes their pension they can withdraw 25 per cent of their pot tax-free. For those with defined benefit pensions the system is simple. If you had £100,000 of retirement savings, you could take £25,000 out tax-free before deciding what to do with the rest. The remaining £75,000 could be used to buy an annuity, go into drawdown or cash out. All withdrawals thereafter will have an income tax at your own personal rate.
Why is George Osborne considering changing it?
George Osborne is under pressure to cut the deficit (thanks largely to his own promise to balance the books) and the pension tax relief bill is a big one.
He has given savers and pensioners flexibility in recent years under pension freedom rules – effectively giving savers over 55 unfettered access to their retirement pots. But now those yet to retire could be in the firing line for a tax raid.
Anyone saving into a pension benefits from tax relief on the way in as well as the 25 per cent tax-free at retirement. This principle of tax-free pension saving dates all the way back to the Finance Act of 1921. But this is judged to be expensive, especially the chunk going to higher rate taxpayers (who get more of it, as they pay more tax).
Tax relief costs the Treasury £34billion a year, and the 25per cent lump sum alone is believed to cost £4billion. Instead, the Treasury has been consulting on ways to reform pensions tax relief which could see it scaled back, or replaced with an Isa-like system. Much of the focus has been on the prospect of cutting tax relief to a flat rate, of potentially 20, 25 or 30 per cent.
How quickly could this happen?
The Chancellor has a nasty habit of bringing in big tax changes quickly to avoid anyone finding loopholes. For example when he changed the stamp duty thresholds from a slab to a progressive system in his 2014 Budget, the changes came in at midnight.
He could bring in any changes to pension tax relief straight away to stop people piling money into their pensions ahead of the changes. However, it is thought that any changes would only apply to new pensions rather than those who have already built up savings.
There are valuable planning opportunities available ahead of this possible change that are not to be missed. To find out what this means to you and to see how we may be able to help you further please contact me at this office.
Terry Lawson DipCII,
Partner, Ad Valorem Wealth Creation LLP
t: 01908 219100
m: 07714 844783