IFS reccomendations - £100 k max lump sum tax free from pension

YoungSaver20

Hi all thoughts on this report published by IFS on 6th February 2023?

https://ifs.org.uk/publications/blueprint-better-tax-treatment-pensions

I know just a proposal and doesn’t mean it’s going to happen but it has made me double think my approach to saving as I contribute 32 % of my salary each month and my employer contributes 12 % so once you add the employer NIC, it’s £1463 a month.

However I still have at least 23 years to nMPA (likely will be higher if the government keep increasing the age)…so if they are considering any of these proposals and phasing them in likely I’ll be impacted.

Maybe I’m a bit thick but despite reading this multiple, the only parts I understand are 25 % tax free component - capped at £400 k (£100k)
And should you die before 75 and what this means for beneficiaries.

Anyone please able to explain points 2 and 3 with examples to help me understand?

oh and I am struggling to understand what the 6.25 % part means…and how any of these proposals are better for low and middle earners ?

1. the 25% tax-free component - the report suggests that the tax-free lump sum should be capped so that it only applies to the first £400,000 of accumulated pensions wealth, at a minimum. This aims to provide a more equal subsidy to all private pensions, benefiting those with a low retirement income

IFS states:

‘‘ going further, we propose providing the equivalent of a capped 25% tax-free component for basic-rate taxpayers, but designed in a way that increases the after-tax value of everyone’s pension (up to the cap) by the same proportion – basic-rate, higher-rate and non-taxpayers alike. A 6.25% taxable top-up on all pension withdrawals would achieve this’’

2. the exempt-exempt-exempt (EEE) employee National Insurance Contributions (NICs) relief – the report declares this should be ended and replaced where all individual pension contributions receive up-front relief equivalent to the rate of employee NICs. Gradually, the system should move to one where pension withdrawals are subject to employee NICs

this exempt-exempt tax (EET) approach seeks to align the employee NICs treatment of pension saving with that of income tax. The report explained ‘‘because the employee NICs rate falls from 12% to 2% at the upper earnings limit, this treatment would benefit low and middle earners (who would get up-front relief at 12% and would typically have only part of their pension income above the NICs threshold in retirement) relative to higher earners who make individual contributions (who would get up-front relief at just 2% but would often pay an average rate of NICs far above that in retirement)’’

3. the EEE employer NICs treatment of employer pension contributions – IFS suggests this should be abolished and instead recommends applying employer NICs to all employer pension contributions alongside introducing a new subsidy on all employer pension contributions. It reveals ‘‘whenever the employer NICs rate changes and ensure a uniform incentive for all employers, including those not  currently liable for employer NICs (such as small employers) for whom the current NICs exemption is worthless’’

4. tax treatment at death - when an individual dies before age 75, funds that remain in a pension escape income tax entirely. IFS proposes income tax should apply on withdrawals from inherited pensions regardless of the age of death. Secondly, pension pots at death are usually not counted as part of the deceased’s estate for inheritance tax purposes. Therefore, IFS proposes that if there is inheritance tax, it should apply to all forms of wealth and pension pots should be included in estates. The report implies that these measures would raise additional revenue

5. pension limits – the report indicates these should be redesigned with distinct approaches for defined benefit (DB) and defined contribution (DC) arrangements. For DB arrangements, IFS suggest use of regulation to place a cap on the pension benefits. For DC arrangements, IFS propose replacing the current lifetime allowance with a lifetime contribution cap.

IFS says:

‘‘there is an even stronger case for a substantial increase in the annual allowance, and in particular the policy of tapering the annual allowance for very high earners should be ended. This would have the benefit of equalising incentives to save across extremely high and merely very high earners’’. 

The model presented in the report indicates ‘‘these reforms would be close to revenue-neutral in the long run, although there is a lot of uncertainty around this estimate…The up-front cost of the package would be £3.3 billion, less any revenue raised from imposing NICs on the pension income of those currently drawing pensions (which would raise around £750 million for every 1 percentage point of NICs charged)…There would need to be a careful transition towards this long-run position. Specifically, where reforms would affect how already-accumulated pension wealth would be treated on withdrawal, there would be a trade-off between implementing a better system more swiftly and taxing some more heavily than they might have anticipated when they made the decision to save in a pension’’.

NedS

I have no issue with transitioning to a system whereby NI relief is given on contributions and NI is then levied on pension income, but I'd be mightily unhappy if NI were now levied on my pension income where I had not received the same relief on those contributions - that double 12% taxation would be very unfair.

I do however note that such a system may go some way to addressing perceived imbalances between DB and DC schemes, whereby a member of a public sector DB scheme contributes relatively little and thus would benefit less from NI relief by way of their relatively small contributions for a relatively large DB pension which would now attract higher NI upon payment.

dunstonh

Multiple threads already on this in the ISA section.

tacpot12

It's the last part of the last sentence that worries me. I have made the decision to retire based on an assumption that NICs would not be payable on pension income. The report (thank you for the link) suggests that its proposals produce a result that would be better for me, but I would need to consider and understand all the implications of the changes before I would accept this suggestion.  

I can't claim to fully understand the proposal in point 2, but it seems to be proposing to change the technical method by which pension contributions are exempt from NI contributions so that high earners lose some (and probably nearly all) the exemption, but low/medium earners are still fully exempt. 

Again with point 3, I can't claim a full understanding of why the current system is less than ideal, but they are proposing that employer contributions to pension are no longer exempt from NI contributions (at the employers rate), but a new subsidy is introduced that allows the Chancellor to reduce the subsidy over time to force employers to may more tax while keeping NI rates the same.

Point 3 is basically Smoke-and-mirrors to avoid employers and employees realising that tax rates are being increased. Ditto with point 2, but only higher earners are affected. 

At the end of the day, a report from an organisation like the IFS is just a suggestion to the Chancellor of how he might make tax more (or less) fair. Politicians need to learn to stop fiddling with the tax system because it is stability that produces growth, whereas uncertainty just hinders it. 

EdSwippet

dunstonh said:

Multiple threads already on this in the ISA section.

The Resolution Foundation's suggested £100k ISA limit and the IFS's suggested £100k PCLS limit are different suggestions on different things and from different "think tanks".

Where they are similar though is the implication yet again that people who have taken the time and effort to provide for their own retirement are somehow evil freeloaders who must now be punished

dunstonh

The Resolution Foundation's suggested £100k ISA limit and the IFS's suggested £100k PCLS limit are different suggestions on different things and from different "think tanks".

Thanks for the clarification.   Another day, another think tank trying to promote it's brand via the media!

Where they are similar though is the implication yet again that people who have taken the time and effort to provide for their own retirement are somehow evil freeloaders who must now be punished

Not a surprise.  The current narrative is that the poor shouldn't pay any taxes.  The wealthy who pay the most in taxes should be driven out of the country as having no tax from them is better than having large amounts.  And the middle ground who should all be dragged down because doing the right thing is now the wrong thing and someone has to pay for the stupid anti-wealth agenda.

Albermarle

Should be noted that AFAIK anyway , no government ( or Labour ) politician has mentioned any of these proposals at all ( in public anyway) , so it is just suggestions from a ( respected) think tank only.

In my personal opinion the 25% tax free is too popular to be touched.
However the generous tax treatment of beneficiary pensions, especially of you die before 75, is not very logical and is an obvious and easy target.
Including pensions in IHT calculations to some extent could be on the cards at some point, but would presumably need some complex legislation due to the Trust aspects ? so more one for the medium term maybe.

dunstonh

In my personal opinion the 25% tax free is too popular to be touched.

It is also one of the smallest of tax perks that costs the treasury.  
If you look at the way salary sacrifice has ballooned over the last 25 years, that would make an attractive target.

I think we are heading to the closure of the current pension tax wrapper and the creation of a new tax wrapper.  The current wrapper has too many legacy issues.    The fact there is both a contribution limit and a lifetime allowance based on value it grows to is not good taxation.    You cannot try and fix one problem as it creates another.

zagfles

The IFS don't seem to have thought this through. And they're one of the more sensible "think tanks"!

Employee NICs on pension income? How's that going to work then. Employees don't pay NICs once over the state pension age, will that change? Employees in 2 or more jobs have a NIC threshold in each job, so if they had multiple jobs paying £12k each they'd pay no NICs regardless of how much they earned in total. So how would that work with pensions? Instead of withdrawing £50k from one SIPP, set up 4 SIPPs and withdraw £12,500 from each SIPP and no NICs payable

Alternatively, have one SIPP and withdraw the whole £50k in one month and the NIC rate will be mostly 2% rather than 12%.

Unless the way NI is charged is restructured then it'd be far too easy to avoid with flexible pension income.

The 6.25% taxable top up rather than the TFLS? Yeah, it replicates the TFLS benefit pretty well with people who pay basic rate tax in work and in retirement. But those who want to retire early and contribute 100% of their salary into a SIPP, get 20% (or will it be 32%?) relief on income within the PA, and intend withdrawing just up to the PA in retirement, would, as well as getting 20/32% relief on the way in and 0% tax on the way out, get an extra 6.25% top up! It would encourage early retirement, something I thought they wanted to discourage.

YoungSaver20

zagfles said:

The 6.25% taxable top up rather than the TFLS? Yeah, it replicates the TFLS benefit pretty well with people who pay basic rate tax in work and in retirement. But those who want to retire early and contribute 100% of their salary into a SIPP, get 20% (or will it be 32%?) relief on income within the PA, and intend withdrawing just up to the PA in retirement, would, as well as getting 20/32% relief on the way in and 0% tax on the way out, get an extra 6.25% top up! It would encourage early retirement, something I thought they wanted to discourage.

So is that if say someone has a £100,000 pension pot and decides to withdraw £10,000 a year, they would get an extra £625 uplift each withdrawal?

zagfles

YoungSaver20 said:

zagfles said:

The 6.25% taxable top up rather than the TFLS? Yeah, it replicates the TFLS benefit pretty well with people who pay basic rate tax in work and in retirement. But those who want to retire early and contribute 100% of their salary into a SIPP, get 20% (or will it be 32%?) relief on income within the PA, and intend withdrawing just up to the PA in retirement, would, as well as getting 20/32% relief on the way in and 0% tax on the way out, get an extra 6.25% top up! It would encourage early retirement, something I thought they wanted to discourage.

So is that if say someone has a £100,000 pension pot and decides to withdraw £10,000 a year, they would get an extra £625 uplift each withdrawal?

Sounds like it, as an alternative to the TFLS.

So for a basic rate taxpayer in work and retirement it would work out the same.

Situation now: take £10,000, get £2500 tax free, £7500 taxable at 20% so £1500 tax, net income £8500

IFS proposal: take £10,000, get £625 top up, all taxable so £2125 tax paid, net income £8500

But it'd be a massive bonus to those who have spare PA in retirement, eg those who retire early (those who retire at SPA will usually have the state pension using most of their PA).

Pay £8000 into a SIPP, gets grossed up to £10,000 even if no tax is paid on earnings.

Withdraw £10,000, gets £10625 with the top up.

Add in NI relief and it'd be even better for early retirees.