Yahoo Finance How the Tories freed your pensions – then locked them up again
It’s been eight years since former chancellor George Osborne’s ‘pension freedoms’ liberated the savings of millions of people in retirement. As well as introducing more flexibility on how you spend your pension savings, the legislation made it easier to pass on pension savings to dependants by reducing the tax rate.
The Government hailed the changes as the biggest shake-up to pensions in a century. Recent Conservative governments have stopped short of making any radical pension changes since then – despite government figures showing 60 per cent of people are not saving enough for an adequate standard of living in retirement.
It is now thought that the Chancellor, Jeremy Hunt, could enact long-overdue increases to pension saving allowances in his spring Budget this week to encourage people to work longer and save more into their pensions.
However, as Telegraph Money explains, people will still have far less freedom over their retirement savings than they enjoyed at the start of Mr Osborne's pensions revolution.
Policy experts have also suggested some of Osborne's central reforms – such as the 25pc tax-free lump sum – are also now under threat.
Savers waiting longer for retirement
When the pension freedoms were introduced in April 2015 it was possible for most people to access their private pensions at 55 without attracting a large tax bill. But from 2028 you will not get access until you are 57.
This is still 10 years below the state pension, and some believe further delaying the age at which people can access private pension pots would be better than further increases to the state pension age.
But Sir Steve Webb, partner at consultancy LCP, says there is no justification for an increase.
He said: “If people needed to access their pension at 55 they will in future simply do so at 57, and in either case this money is then not available for later retirement.
“Changing the minimum pension age will have no real impact on people’s long-term retirement prospects but does make the system far more complex. It would be better if the Government simply left things as they are."
Penalised for accessing your pension early
Everyone can withdraw 25pc from their pensions as a tax-free lump sum upfront. You might be tempted to access this cash in your late 50s or early 60s to pay off debts or ease cost of living pressures – particularly if you lose your job.
But once you withdraw more than the tax-free lump sum, you are severely restricted on how much you can pay back into a pension under the Money Purchase Annual Allowance (MPAA). When introduced in 2015, the MPAA was £10,000 but was cut to £4,000 in 2017 with no justification and has been frozen since then.
The MPAA only applies to defined contribution pensions. Those who receive a defined benefit or final salary pension may still get the full £40,000 annual allowance.
Mr Hunt has been reported to be plotting to increase the MPAA in Wednesday's Budget.
Allowances eroded over time
The lifetime allowance restricts how much you can save into pensions. In 2015 the lifetime allowance limit was £1.25m, but it dropped to £1m a year later and has been frozen at £1.073m since 2020.
The frozen lifetime allowance has been blamed for encouraging some senior NHS staff to retire early, as well as other public sector and private workers.
Mr Hunt is expected to announce significant increases in the lifetime allowance in the Budget. There could also be changes to the annual allowance. Most people can save up to £40,000 into a pension each year, an amount that has remained the same since 2015 and has failed to keep up with inflation.
Meanwhile, the annual allowance is much lower for high earners. It begins falling for people earning over £240,000 and drops to £4,000 for earnings above £312,000. In 2016, the UK’s highest earners could pay £10,000 a year into a pension.
Now being told to work longer
There has been concern about the rising number of over-50s leaving the workforce to retire. The number of people who are “economically inactive” has risen by 565,000 since the start of the Covid-19 pandemic, with early retirement the biggest contributor to the change.
Some say UK private pensions are too generous, and that changes should be made to encourage people to stay in work longer and to make the system fairer to lower-paid workers. So what’s being suggested?
Capping the tax-free lump sum
You can withdraw 25 per cent of your private pension savings as a tax-free lump sum upfront. It is therefore possible to withdraw sums of around £250,000 without paying any tax.
A recent report from the Resolution Foundation recommends the Government caps the tax-free lump sum. The foundation said the option to withdraw potentially hundreds of thousands of pounds, tax-free, encourages wealthy individuals to retire well before the state pension age at “considerable expense to the taxpayer”.
Flat-rate tax relief
Every year there are rumours that the Government will make changes to tax relief on pension contributions.
Currently you get 20 per cent tax relief on pension contributions, but higher-rate earners can claim back an additional 20 per cent and workers paying the top rate of income tax can claim back a further 25 per cent – taking the total tax relief to 45 per cent.
The Government has given serious consideration to introducing a flat rate of pension tax relief in the past, with the suggested amount as low as 25 per cent.
“A flat rate of tax relief of 30 per cent could act as a stronger incentive for basic-rate taxpayers to pay into a pension, and would reduce the cost to the Government of offering tax relief to higher earners,” says Becky O’Connor, director of public affairs at PensionBee.
Changing pension inheritance rules
If you have a defined contribution pension and die before the age of 75, those who inherit the pension will not have to pay any income tax. Pensions are also free of inheritance tax.
In a recent report, the Institute for Fiscal Studies said this creates a “bizarre situation” where wealthy individuals are more likely to see pensions as a vehicle for bequests than providing retirement income.
The IFS said income tax should apply if the saver dies before 75 and that private pension savings should be liable for inheritance tax.
