Question about 25% lump sum

jamesd

AnotherJoe wrote: »

I'm wondering if this loophole may be closed in the budget, eg no more contributions once you've drawn any money. It seems like a crazy loophole to me.

Taking money from a pension doesn't mean that you've stopped working or fully retired. You might be made redundant and effectively compelled to take a pension then but not have enough to fully retire. Or you might have a pension mortgage that requires taking the 25% to pay it off by a certain date but not be anywhere close to actually retiring.

A little while ago the rules were changed to reduce the annual contribution allowance to £10k from £40k once you've taken out more than the 25% tax free lump sum. that limits how much scope there is for this sort of thing but doesn't eliminate it.

It's very fiddly to come up with a rule that covers the normal life events and withdrawing patterns but limits this, though there is some scope for it, say after state pension age unless still working.

dunstonh

The breakdown of the cost of tax benefits is published as follows (for 2013/14)

tax relief on contributions £34.3 billion
a tax-exempt 25% lump sum at retirement £2.5 bn
NICs relief on employer contributions £14 bn
tax relief on investment income £7.3 bn.

So, when you look at it, scrapping the 25% TFC is fairly insignificant. The big hitters are NIC relief and tax relief.

Another interesting bit was the tax on pensions in payment (exc state pension). That brought in £13.1 bn in 2013/14. You can see why making (non state) pension income tax free and killing tax relief on contributions would be attractive for deficit reduction. It would be popular with the grey vote too. Not so much with higher earners.

westv

What would be the point of taxing on the way in but not on the way out - like an ISA? Surely people would then just buy a normal ISA they could get to easily rather than tie funds up for decades?

EdSwippet

dunstonh wrote: »

Another interesting bit was the tax on pensions in payment (exc state pension). That brought in £13.1 bn in 2013/14. You can see why making (non state) pension income tax free and killing tax relief on contributions would be attractive for deficit reduction.

Interesting figures indeed.

Worth noting that this £13.1bn in tax paid by today's pensioners is the direct result of tax deferral that happened in past years and which would have 'cost' far less than £35bn. And in future the tax paid on this year's £35bn of tax deferral will be much higher than this £13.1bn figure, because of growth, inflation, and because the initial tax deferral is higher to begin with. There is a balance here, but it's hard to see because of the time lag.

Killing tax relief on contributions produces a one-off bump in revenue due to timing effects, but it is not sustainable and not close to a long-term solution, just a band-aid. If the government is short-sighted enough to make it happen, then once its effects have worked through the system it is exhausted.

At that point should we just hope that the government never runs a deficit again? And when it does, because it surely will, what gimmick will it resort to down the line now that this one is no longer available?

talexuser

westv wrote: »

What would be the point of taxing on the way in but not on the way out - like an ISA? Surely people would then just buy a normal ISA they could get to easily rather than tie funds up for decades?

You could stash more eventual tax free income in both ISA and pension, in the same funds if you wish? Just can't get at the pension bit till 55?

dunstonh

EdSwippet wrote: »

Interesting figures indeed.

Worth noting that this £13.1bn in tax paid by today's pensioners is the direct result of tax deferral that happened in past years and which would have 'cost' far less than £35bn. And in future the tax paid on this year's £35bn of tax deferral will be much higher than this £13.1bn figure, because of growth, inflation, and because the initial tax deferral is higher to begin with. There is a balance here, but it's hard to see because of the time lag.

Killing tax relief on contributions produces a one-off bump in revenue due to timing effects, but it is not sustainable and not close to a long-term solution, just a band-aid. If the government is short-sighted enough to make it happen, then once its effects have worked through the system it is exhausted.

At that point should we just hope that the government never runs a deficit again? And when it does, because it surely will, what gimmick will it resort to down the line now that this one is no longer available?

The tax relief figure and NI relief are growing at greater amounts than the tax recovered on pension income. So ,whilst I agree with you that it would likely be a short term fix with long term issues, the cost of relief (including NI) is getting out of control and since when have MPs ever thought long term

Another notable thing with the figures is that the tax relief on individual contributions has barely changed since 2001. £5.1 bn in 2001 to £6.8bn. In that same time, employer contribution relief rose from £3.8 bn to £20.2bn. That cant all be blamed on auto-enrolment. The employer tax cost actually fell between 2011-2013. The big jump was between 2001 and 2005. NIC relief also nearly trebled in that 13 year period.

I had heard that tax relief cost had gone up £4bn in the last year alone. That may be auto-enrolment related (as large companies would likely have had an occupational scheme but small companies not until they had to) but it could also be highest rate taxpayers looking to reduce their bill. I have seen significant increased activity in recent years of higher/highest rate taxpayers using the pension as a tax vehicle rather than a retirement plan.

jamesd

dunstonh wrote: »

tax relief on contributions £34.3 billion
a tax-exempt 25% lump sum at retirement £2.5 bn
NICs relief on employer contributions £14 bn
tax relief on investment income £7.3 bn.

If I play at being Chancellor the tax relief on employer contributions looks very interesting. Typically 13.8% for the employer portion of pension instead of pay (sacrifice, DB typically) and it is payable up to any pay level, without limit. Cutting the relief for that "employer NI" portion but not the "employee NI" portion would have the interesting advantages of:

1. Saving money for the Budget soon.
2. Continues to increase as pay increases, with fewer dodges than for income tax.
3. Might also have an "unless paid into pension of employee" clause for say half or all of it that would presumably encourage employers to do that with it instead of paying HMRC. Which in turn would give back much that might have been taken from DB while encouraging more into DC. Half is interesting because that is a fairly common proportion of the employer NI that is paid into employee's pensions in DC salary sacrifice schemes, so potentially the DC employees might see no change in their benefits.

AnotherJoe

jamesd wrote: »

Taking money from a pension doesn't mean that you've stopped working or fully retired. You might be made redundant and effectively compelled to take a pension then but not have enough to fully retire. Or you might have a pension mortgage that requires taking the 25% to pay it off by a certain date but not be anywhere close to actually retiring.

A little while ago the rules were changed to reduce the annual contribution allowance to £10k from £40k once you've taken out more than the 25% tax free lump sum. that limits how much scope there is for this sort of thing but doesn't eliminate it.

It's very fiddly to come up with a rule that covers the normal life events and withdrawing patterns but limits this, though there is some scope for it, say after state pension age unless still working.

All good points. I stand corrected.

EdSwippet

dunstonh wrote: »

The tax relief figure and NI relief are growing at greater amounts than the tax recovered on pension income.

But isn't that just the time-lag effect? Once the folk claiming the current tax deferral and NI relief retire, then the tax recovered on pension income will increase correspondingly. Even more so, in fact, because of expected growth during the interim.

Put differently, today's tax take on retirement income reflects tax deferral from a long way in the past, when deferral figures were lower. Future tax take on retirement income will reflect today's tax deferral, and since deferral figures are now higher it too will be much higher.

In effect this is no different to the deferred gratification the government expects pension savers to understand and implement. Except that in this case it is the government, and not pension savers, that is unable to wait. Killing tax deferral would be eating seed corn.