"Unsecured" pensions

Milarky

From the Telegraph, 5 Sept 2005

Higher-rate taxpayers can take more than 70pc of the contributions made from their own pocket out of their pension fund from April next year without having to actually draw a pension...

[Thanks to: EdInvestor for pointing this out]

Milarky

What I'd like to know is how it is allowed that higher rate taxpayers would be able to claim the uplifted relief -from 22% to 40%- in full rather than only in the proportion of one quarter [i.e. as would occur under normal rules]?

IF this is an accurate description then it obviously assists HR taxpayers whilst appearing to do nothing additional for basic rate taxpayers aside from access to the lump sum without converting the residual amount to an anniuty...

THE effect for HR taxpayers is that they effectively draw a lump sum of 40% rather than 25%: Although the example shows a £100 gross payment as leading to a lump sump of £19.23 plus £23.08 [£42.31], this only leaves an unsecured pension fund of £57.29 - £2.31 less than was handed over in the first stage. Thus the £2.31 has to be held back and reduces the effective lump sum to about £40....

ANYWAY, whilst it looks a nice earner for 50-55 year olds on HR tax, can anyone explain just how it is that a further 18% relief is recoverable directly rather than the £60 plus £40 conventional tax relief going straight in as now?

Thanks

Pal

Yet another publicity seeking adviser who has found a wonderful "loophole" in regulations that have not yet been written.

Ignore until the final regulations are published.

dunstonh

Agree Pal.

Indeed, highlighting points like that now almost certainly means that the "loophole" will be closed before April. If it hadnt have been pointed out, there may have been the chance it was missed and people would have had 12 months of being able to do it before the following years finance act closed it.

EdInvestor

It's from the Telegraph

Isn't it just phased drawdown - same principle as immediate vesting annuities?

Milarky

EdInvestor wrote:

It's from the Telegraph

Isn't it just phased drawdown - same principle as immediate vesting annuities?

The difference appears to be that these USPs would be on-going plans, as I read it. Thus at age 55 [after 2010] the lump sum is accessible whatever form of plan has been held till then PLUS further contributions will attract an optional £25 pay-out for every £78 net [basic rate taxpayer] contribution. This defrays the 'cost' immediately - from £78 to £53 and you are deemed to have 'unsecured' [in the sense of not having yet taken, I assume] a further £75 of pension. It's attraction - even for BR taxpayers - is that the lump sum becomes available in their mid-fifties, and the cost of future payments into their pension [between 55 and 75] is defrayed. As the point of a pension is to act as an 'insurance policy' in the event of surviving into old age, you shouldn't really need the lump sum then when you are too old to enjoy it.. Maybe this is the thinking.

Yes, some people do actually use the 'lump' to purchase extra pension, but I'd assume nearly everyone doesn't. The argument against this option is that too little income remains in the 'unsecured' pension and taking the lump removes a 'cushion' prematurely. I'n not so sure, given that the population as-a-whole is going to be a lot more conversant with pensions saving in the future. People really ought to be trusted with this kind of flexibilty.

Milarky

Here's the second instalment from the Telegraph, 10 Sept 2005... They're going to town on it...

The system works because of the way that tax relief is applied to pensions - something that is so difficult to understand it even foxed our experts earlier this week....

[Hmm!!]

EdInvestor

The Telegraph seems to be forgetting that you have to pay tax on this money when you take it out as a pension - at 40% or 22% whichever is your higher rate.So as usualy the benefit is just in the 25% tax free cash.

Milarky

I've just crawled over their description on how this works and I think it is actually 'neutral' - there being no more 'free money' than allowed under pension contributions made today:

Apparently what you do is

1) Pay in £78, get £22 credited [Value of 'contribution': £100 - so £18 can be recovered later if you are a HR taxpayer]

2) Draw off £25 [Which you 'keep' presumably, as now?]

3) Take your notional £18 and then 'recycle' it

4) Depending on what you do, you can either 'recycle to extract' the rebate element - leaving you with slightly less in your fund anyway - or else 'recycle to maximize' - so that you extract no more than the £25 original lump sum drawn on the £100

5) Doing the latter, you get a final additional pension element of £30 [Worked out as below*]. This gives you a 'fund' of £105 and a 'lump' of £25 - total £130. If you had just paid in £78 as a HR taxpayer today, this gives a total of exactly the same figure - £130, but with a lump of £32.50 [25%] and a fund of £97.50 [75%]

6) Doing the former - 'recycling to extract' - simply removes 25% of each cycle of investement - resulting in the £30.00 being split £22.50:£7.50 - and giving a split identical to direct contributions [made at 60% now] of £97.50 'fund' and £37.50 'lump'.

So, have I missed something here, or will the Telegraph have to rewrite its article's conclusions?

*My workings out:

£60 --> £78, which is [78/60ths].

The rebate is just £18 for this £78 net payment, therefore [18/78ths].

If ALL this is recycled.

Result: Additional amount invested = £18 x (1/0.78) x /size]1 + (18/78) + (18/78)^2 + (18/78)^3 + ...[size=3

The amount in the big braces [] is just 78/60. When you put this into the big expression, it becomes: £18 x (1/0.78) x (78/60) = £18 x (100/60) = £30

dunstonh

The Telegraph seems to be forgetting that you have to pay tax on this money when you take it out as a pension - at 40% or 22% whichever is your higher rate.So as usualy the benefit is just in the 25% tax free cash.

What about non rate tax payers and the lower rate taxpayers. Investing into a pension does not automatically mean you will be a tax payer in retirment.

cheerfulcat

Milarky wrote:

2) Draw off £25 [Which you 'keep' presumably, as now?]

No. If you read the article again you'll see that the whole point of "recycling" is that you are using the £25 lump sum plus the £18 tax rebate to make another contribution, at which point you get another lot of tax relief.