Do we want people to save for pensions or not?

So here we are again. As long as I have been in pensions the question of the continued availability of a tax-free lump sum has refused to go away. And guess what, it is back again!

Every year the question is asked about abolition, and people look for clues as to whether this is the year that it will happen.

In 2002, Chancellor Gordon Brown reassured us that the tax-free lump sum would be safe in their hands and it did form an ongoing part of the pension simplification regime introduced in 2006.

However, the more cynical commentators suggested that the change in name from “tax-free cash sum” to “pension commencement lump sum” was the sure sign of a future change, specifically given that the words “tax-free” had been removed.

In the last few years we have seen various think tanks suggesting removal including Centre Forum (where Steve Webb worked for a while) and the Centre for Policy Studies.

As the rumours have come and gone, some have taken action just in case.

This approach really came home to me at a conference I was doing this time last year, and just before the introduction of the pension freedom rules, when one of the delegates, an accountant, approached me after the session and confirmed that he had a cheque for £500,000 in his pocket as he had just taken out his lump sum! You know, just to be safe!

Surprise, surprise, rumours are back again in 2016 and with a couple of possible justifications.

If the Chancellor went against nearly all public opinion and introduced the pension ISA on a TEE basis then technically the tax-free status of the lump sum would disappear. All contributions on the way in would be taxed, and all payments out would be tax-free, sneakily doing away with the 25% allowance, and with significant saving to the Exchequer. Steve Webb recently suggested that such payments could be on the “brink of extinction...”

The second justification comes when trying to rationalise the true reason for tax relief. One logical explanation for tax relief and the premise of higher earners getting higher rate relief is that it is not really tax relief but tax deferral. You will pay tax when you take the money out of the pension and not when you put in; it is the reward for deferring the consumption of that particular sum of money. If this logic is accepted then there would appear to be no logic for the tax-free element other than perhaps a tenuous argument that that it is the reward for deferral?

So will we see the end of the tax-free lump sum in the forthcoming budget? If so it would not be well received as many individuals see the tax-free lump sum as the real incentive for pension saving.

This issue is made worse by the fact that many pension savers have earmarked the tax-free element of their pension plan to pay off a specific debt (c.f. the so called “pension mortgages”).

It will also be difficult to rationalise that some defined benefits schemes offer either a lump sum alongside a lower annual accrual rate or even the ability to commute part of the pension for tax-free cash. The mechanism is integral to the scheme and particularly in the case of public sector pensions there would be real opposition to change.

The other question is how would it be restricted? The pension industry is full of situations where there are transitional restrictions to protect the benefits accrued before the date of any change so that the restriction only applies to the newly accruing benefits. Would there simply be a blanket tax-free cash ban on any newly accruing benefits or would there be a limit to the maximum that could be taken at retirement?

In any event the savings to the Chancellor would surely be slow coming as it would only be the new accruals that carried no entitlement to tax-free cash.

From both an industry perspective and a political perspective the availability to take a tax-free lump sum is being regarded more and more as an anomaly that will eventually disappear. From a “savers” perspective, however, it is perhaps the key reason for pension saving and any change to it would seriously affect future pension planning.

Again we are back to another perennial question, do we want people to save for pensions or not?

Head of Platform Technical

Mike Morrison has worked in financial services for far too many years. In 1990 he joined Winterthur (now AXAWealth) as Technical Manager, playing an instrumental role in the development of their SIPP product and later their pioneering work on income drawdown.

Mike is an ex Chairman of AMPS (the Association of Member Directed Pension Schemes) and is on the Financial Planning Committee of the ICAEW. He is also an Associate of the Pensions Management Institute and the Chartered Insurance Institute, and he holds both an LLB and an LLM in European Law.

An accomplished speaker and writer on financial services matters, Mike is passionate about retirement and savings issues, and how we can better communicate these to a wider audience.

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