Treasury in line for pension tax windfall

The UK pension reforms due to be implemented next April will result in a £1.6bn cash windfall for the government as savers rush to withdraw their money, new research suggests.

Official figures from the Office for Budget Responsibility put the likely tax boost from the freedoms, which allow savers to take all their accumulated pension savings from age 55, rather than being compelled to buy an annuity, at £320m in 2015/16, rising to £1.22bn in 2018/19.

But based on research by Ipsos Mori, financial services group Hargreaves Lansdown estimates that the windfall is likely to be at least £800m and could reach £1.6bn in the first year alone as savers, largely ignorant of the tax consequences of their actions, withdraw money in bulk.

The survey of 1,247 adults aged between 45 and 65 found that 12 per cent of investors in a defined contribution scheme planned to take all their pension savings in one go. Hargreaves extrapolated that figure using population and pension data to estimate that 200,000 retirees are waiting to get their hands on their pension pots. The average value of a defined-contribution pension fund is about £29,000.

However, fewer than two in five respondents could accurately state what rate of tax would apply to a medium-sized pension pot and fewer than one in 10 could say what tax would apply to a large fund.

The rules allow for 25 per cent of a pension fund to be taken tax free, as is the case at present, with withdrawals beyond that level taxed at the individual’s marginal rate. Someone retiring next April with an income of £20,000 and encashing a pension fund of £30,000 would be able to take £7,500 tax free, with the remaining £22,500 taxed alongside other sources of income, resulting in a total tax charge to the pension fund of £4,543 or about 15 per cent.

Questioned about what they would do with their fund, 13 per cent said they would pay off debt – generally regarded as a sensible course of action. However, many others said they would spent it, often on things that would incur additional tax. A fifth of respondents said they would go on holiday (likely incurring VAT at 20 per cent) and 16 per cent would invest in property (incurring stamp duty at rates varying from zero to 7 per cent, plus potential income and capital gains taxes in future).

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“This research suggests that many people will take advantage of the new freedoms, pay more tax than they expect and then run out of money before they die,” said Tom McPhail, director of pensions research at the firm. “This doesn’t look like a good way to run a pension system.”

The government is hoping that free guidance at the point of retirement will protect retirees from behaving recklessly or falling victim to mis-selling and recently appointed Citizens Advice and the Pensions Advisory Service to help deliver that service. However, with less than six months until the freedoms go live, the template of the guidance conversation, the signposting and the methods of delivery are still unclear.

Criticism of the pace and magnitude of the reforms is growing, even from parts of the financial services industry that might benefit overall from greater flexibility. Mr McPhail recently said that the Chancellor was on a “reckless pensions joyride” that could “end in a horrendous car crash”.

“Taking your pensions savings as cash is fine but only once you have secured enough income for life. This has to be thought through,” said Alan Higham, retirement director at Fidelity.

A spokesman for the Treasury said that face-to-face, online and telephone-based guidance would be available for all who wanted it.

“People who have worked hard and saved all their lives should be free to do what they want with their pensions. That freedom is a key part of our long-term economic plan,” he added.