A million people trapped by ‘pension freedoms’

As George Osborne luxuriates in the £3 million Verbier ski lodge funded by his portfolio of jobs since leaving Downing Street, he might smile secretly that his 2015 ruse has worked a treat.

If his goal was to bamboozle financially illiterate people into actions that would swell the coffers of the Treasury, he has 980,000 reasons to give himself a pat on the back. That’s how many people have fallen into his carefully laid trap.

How so? If you are over 55 you can start to withdraw cash from your pension plan. However,  if you withdraw too much the amount you can contribute plummets from an already miserly £40,000 a year to a pathetic £4,000 a year. And guess what happens if you try to make a contribution back into your scheme of more than £4,000? Why, it gets taxed at 55% of course.

So what triggers the draconian cut in your annual contribution allowance? There are several potential triggers, but the most obvious one is if you take a penny more than your 25% tax free allowance. The additional amount is classed as a ‘flexi access drawdown’, which means you trigger the Money Purchase Annual Allowance (MPAA) and 90% of your annual contribution allowance is lost at a stroke.

Other triggers include:

  • if you take your entire pension pot as a lump sum or start to take ad-hoc lump sums from your pension pot
  • if you put your pension pot money into a flexi-access drawdown scheme and start to take income
  • if you buy an investment-linked or flexible annuity where your income could go down
  • if you have a pre-April 2015 capped drawdown plan and start to take payments that exceed the cap

Simples, as our meerkat friends might say.

The idea was, apparently, to discourage people from cycling money in and out of their pension and claiming tax relief each time. But this feels like being hung for a parking offence. Surely they could simply place limits on tax relief on new contributions once draw-down has started?

All these rules only apply to defined contribution schemes, the sort that most of us have unless you are one of the dwindling few to have a defined benefits scheme.

As if the tax penalties weren’t already bad enough, HMRC has made things worse with a cynical approach that is clearly designed to trap the unwary. Whenever anyone takes their first withdrawal under the pension freedoms, HMRC places the person on an emergency tax code as if this lump sum withdrawal was going to become a regular monthly income. With 150,000 pensions a quarter being accessed for the first time, this creates  a massive backlog in claims for repayment of overpaid tax.

Already HMRC has paid back £402 million to 174,000 investors, working out at over £2,300 a head. Industry experts are calling for a change in approach, one describing HMRC as ‘utterly shameless in the way it overtaxes people and expects them to claim a refund’.

One area where we should all be exploiting tax breaks is the £20,000 a year ISA allowance. Unfortunately, that has tended to mean accepting a lousy return on cash or some sleepless nights on the stock markets. However, Uncle Graham has discovered a third way and we’ll be covering it at next Wednesday’s Boardroom Breakfastclick here for full details.

Until next time

Graham