Telegraph reporting - pensions tax threat

DT2001

Too much tinkering with the pension tax rules will deter long term planning. Will it lead to greater reliance on the state in later life.
I do not know the stats but assume the vast majority of people will not be affected by any adverse changes to LTA or HRT relief removal so is it politically acceptable to tweak those whilst encouraging the less well off to make some enforced provision for retirement?
Simplification would be good but that is asking too much IMO.

jimi_man

doodling said:

jimi_man said:

It's an odd stance to come out with 'There is no free money from the Government. Really; no.' and then go on to explain that actually there is free money in the form of the difference between HR/BR tax rates and also Salary Sacrifice. 

Maybe I don't understand the principles but I always thought there was substantial value in it. For example with our hypothetical £1 million pot, the person pays in £600K, it gets enhanced to £1 million (I know it doesn't physically, you have to claim it back but the effect is the same). He then takes 25% tax free (also not mentioned as part of the free money) and then pays 20% on the other £750K, so another £150K.

Thus he's left with £600K and with his £250K that makes £850K in total, as compared to £600K that he's paid in - a difference of £250K - 25% of the pot.

Seems to me to be a substantial amount of free money unless I've got the maths wrong, which is entirely possible? 

I totally get that the employer contribution is not free money. 

I think there is a difference in peoples of understanding of free money.

1. My understanding of free money is that someone gives me some money.

Your understanding of free money appears to be along the lines of: you have £100 in your pocket and I decide not rob you, therefore you have £100 of free money.

There really isn't any free money from the government (except in the case of non-taxpayers making pension contributions).  All that varies is the extent and timing of the tax the government decides to impose.  Different levels of tax are paid depending on rates of pay, rates of pension contribution and rate of pension withdrawal.  The government gets to play the stock market with other peoples money on the side which is probably beneficial to them as well.

2. Your figures are (taking them at face value) show that someone accrues £1m of pension funds and pays tax of £150k.  That feels like the opposite of free money to me.  Note that the tax is the same whether that person is a higher rate tax payer or a basic rate tax payer while they are earning.  The fairness of this arrangement is of course open to discussion.

3. If you want to look at it from a cost point of view then it costs a basic rate taxpayer £800k buy that benefit whilst it costs a higher rate taxpayer £600k to buy that benefit.  That could be considered unfair but only if you look at it in isolation.  In order to buy at this cheap price, the higher rate taxpayer will have had to give the government at least ~£190k in tax over the years (difference between income tax allowance and higher rate threshold times 25 years (£40k pa contribution to get £1m) times basic rate tax).  The basic rate taxpayer may not have given the government any income tax.  The difference is therefore ~£790k vs. £800k cost, not quite such a difference.

If I add in salary sacrifice then the higher rate taxpayer pays ~£770k for their £1m pot whilst the basic rate taxpayer pays £670k.  The fairness of this arrangement is of course open to discussion.

1. A little pedantic (IMO). So by this principle, if this hypothetical person gives you (say) £1000 then with your understanding,  that's 'free money'. But if you owed him £2000 and he says 'fine, you now owe me only £1000', then he's still given you free money but you've used it to offset money that you owe him. Or he might have said 'that 2 grand? I'm feeling generous, let's call it a grand'. Same figures, same principle, same free money and the same as paying (or owing) less tax - something that in the UK we are required to pay. 

2. Incorrect. That £1 million is your earnings for which you should have paid £400k tax. Instead you've only paid £150k. So effectively your hypothetical friend (HMRC) has said 'that 400 grand? I'm feeling generous, let's call it 150 grand'. I'm not sure how that qualified as 'the opposite of free money'?

3. That's a very strange argument and I'm not sure of the relevance as to what I was discussing? I wasn't discussing the differences between the two, merely that saving on taxation is effectively free money since you are not required to pay something that under normal circumstances you would be. 

QrizB

michaels said:

So convert your DB to a DC at 20x and then try and use the pot to buy an annuity paying the same as the DB you have given up....you will find that you need to value the DB at 40 times to make the maths work.

That's not necessarily true, though, is it?

Taking the current example annuity rates from Hargreaves Lansdown the multiplier for a 65-year-old non-smoker varies from 19.8x to 35.9x.

zagfles

QrizB said:

michaels said:

So convert your DB to a DC at 20x and then try and use the pot to buy an annuity paying the same as the DB you have given up....you will find that you need to value the DB at 40 times to make the maths work.

That's not necessarily true, though, is it?

Taking the current example annuity rates from Hargreaves Lansdown the multiplier for a 65-year-old non-smoker varies from 19.8x to 35.9x.

DB pensions are almost always index linked, though sometimes capped, usually with 50% spouse pension, so the comparison should be with an index linked joint life annuity.

2nd_time_buyer

zagfles said:

QrizB said:

michaels said:

So convert your DB to a DC at 20x and then try and use the pot to buy an annuity paying the same as the DB you have given up....you will find that you need to value the DB at 40 times to make the maths work.

That's not necessarily true, though, is it?

Taking the current example annuity rates from Hargreaves Lansdown the multiplier for a 65-year-old non-smoker varies from 19.8x to 35.9x.

DB pensions are almost always index linked, though sometimes capped, usually with 50% spouse pension, so the comparison should be with an index linked joint life annuity.

As someone who has a fairly large DB scheme and wife likewise. I have to reluctantly agree that the 20x seems very low in the current environment. On the flip side annuity rates are also very low at the moment. If the factor was 40x and annuity rates rose, it would look too high.

Linking the factor directly to annuity rates would be a challenge for long term planning - but then so are the highs and lows of investing in the stock market...

As it is, the effectively much larger LTA (and annual allowance) for DB schemes over DC schems seems a little unfair.

Albermarle

As someone who has a fairly large DB scheme and wife likewise. I have to reluctantly agree that the 20x seems very low in the current environment. On the flip side annuity rates are also very low at the moment. If the factor was 40x and annuity rates rose, it would look too high.

I think there was speculation in the past of increasing the multiplier to  25X as at least a step towards a more realistic figure .

I do not know the stats but assume the vast majority of people will not be affected by any adverse changes to LTA or HRT relief removal so is it politically acceptable to tweak those whilst encouraging the less well off to make some enforced provision for retirement?

LTA affects more people than in the past and the number is growing. However you are right it only affects a small minority. However this is not the case with higher rate tax relief , which benefits a significant number of people . Still a minority but mainly Tory heartland voters . The Mail and Telegraph would be bursting a blood vessel if it was removed .

Ganga

DT2001 said:

Ganga said:

I thought that your employers contributions to your pension pot was free money ? am i wrong.
lso if employer A) matched what you put in say 2% , but employer B put in 12% to your 2% surly thats an extra10% free as the employee pays no tax on an employers contributions OR have i got it wrong .

I think the argument would be that the employer contribution was part of the overall package so not free. You might take a slightly lower paid job with higher contribution from your employer as overall you were better off.

I would disagree , when auto enrolment came out ,a lot of people who were all ready in employment found that SOME companies matched or  payed even more into their employees pension pots so free money ,ok i am being pedantic but i think in this scenario i am correct .  

doodling

jimi_man said:

doodling said:

I think there is a difference in peoples of understanding of free money.

1. My understanding of free money is that someone gives me some money.

Your understanding of free money appears to be along the lines of: you have £100 in your pocket and I decide not rob you, therefore you have £100 of free money.

There really isn't any free money from the government (except in the case of non-taxpayers making pension contributions).  All that varies is the extent and timing of the tax the government decides to impose.  Different levels of tax are paid depending on rates of pay, rates of pension contribution and rate of pension withdrawal.  The government gets to play the stock market with other peoples money on the side which is probably beneficial to them as well.

2. Your figures are (taking them at face value) show that someone accrues £1m of pension funds and pays tax of £150k.  That feels like the opposite of free money to me.  Note that the tax is the same whether that person is a higher rate tax payer or a basic rate tax payer while they are earning.  The fairness of this arrangement is of course open to discussion.

3. If you want to look at it from a cost point of view then it costs a basic rate taxpayer £800k buy that benefit whilst it costs a higher rate taxpayer £600k to buy that benefit.  That could be considered unfair but only if you look at it in isolation.  In order to buy at this cheap price, the higher rate taxpayer will have had to give the government at least ~£190k in tax over the years (difference between income tax allowance and higher rate threshold times 25 years (£40k pa contribution to get £1m) times basic rate tax).  The basic rate taxpayer may not have given the government any income tax.  The difference is therefore ~£790k vs. £800k cost, not quite such a difference.

If I add in salary sacrifice then the higher rate taxpayer pays ~£770k for their £1m pot whilst the basic rate taxpayer pays £670k.  The fairness of this arrangement is of course open to discussion.

1. A little pedantic (IMO). So by this principle, if this hypothetical person gives you (say) £1000 then with your understanding,  that's 'free money'. But if you owed him £2000 and he says 'fine, you now owe me only £1000', then he's still given you free money but you've used it to offset money that you owe him. Or he might have said 'that 2 grand? I'm feeling generous, let's call it a grand'. Same figures, same principle, same free money and the same as paying (or owing) less tax - something that in the UK we are required to pay. 

Reducing someone's debt could be considered to be free money, I wouldn't call it that - you can't buy food with reduced debt.  (The old cash flow vs. balance sheet argument).  Both are very different from not taking money off someone.  Taxing someone less is not giving them money it is taking less money off them.  There isn't some universal taxation constant, one side of which is a gift and the other side of which is a tax, its all tax.

2. Incorrect. That £1 million is your earnings for which you should have paid £400k tax. Instead you've only paid £150k. So effectively your hypothetical friend (HMRC) has said 'that 400 grand? I'm feeling generous, let's call it 150 grand'. I'm not sure how that qualified as 'the opposite of free money'?

No I shouldn't have paid £400k tax, the rules are that I don't need to as I'm paying it into a pension.  I am paying exactly the decreed amount of tax.  The tax structure is such that if you do certain actions you pay less tax (this doesn't just apply to income tax and pensions).  Overall the sum has been taxed to the tune of £150k rather than £400k by putting into a pension - that isn't some kind of gift of £250k, its a cost of £150k.  There are no fundamental physical laws which say that 40% tax on everything is "right", if there was I'd be asking why people on Universal Credit aren't paying 40% tax.

3. That's a very strange argument and I'm not sure of the relevance as to what I was discussing? I wasn't discussing the differences between the two, merely that saving on taxation is effectively free money since you are not required to pay something that under normal circumstances you would be. 

Yes, it wasn't really a response to you but was intended to address the "higher rate tax relief is unfair" argument.  It is not as simple as "some people get more tax relief than others and its unfair", there is a lot more nuance.  As above, I note that you are not required to pay tax on contributions to pensions under normal circumstances so I don't quite understand the last sentence.

Malthusian

In a political context pension tax relief and employer contributions are not "free money". As others have said it is merely keeping more of what you earned by working.

Even if you get 40% tax relief on the way in and pay 20% on the way out, this is not free money, this is the effect of spreading your earnings over the years in which you spend the money rather than having the whole lot taxed in your working life. (I.e. ensuring that someone who earns £300,000 in 5 years doesn't pay more tax than someone who earns £300,000 in 10 years just to punish them for working smarter or harder.)

In a financial planning context they are free money. I press one button (opt out of employer pension scheme) and £10 falls out. I press a different button (join employer scheme) and £25 falls out. The same amount of actual work is done whichever button is pressed. Pressing the second button = free money.

mat1964

I really hope they leave salary sacrifice alone - it is really helpful if you're earning above £100k as the loss of the personal allowance means paying in effect 60% tax.  So if you earn £120k and sacrifice £20k for pension contributions, you are getting 60% tax relief on that amount (or more if your employer passes on the NI savings).  Works for salary sacrifice cars also (but only for low emission cars).

https://adviser.royallondon.com/technical-central/pensions/contributions-and-tax-relief/60-tax-relief-on-pension-contributions/