Subject to consultation, from April next year anyone who wants to take their whole pension in cash at 55 can. 25% of that will be tax free (as now) and the rest will be taxed at whatever the pension holder’s marginal income tax rate is (subject to the lifetime allowance limits of course – see my blogs here and here, and James Ferguson on the matter in this week’s magazine).
Peter Hargreaves of Hargreaves Lansdown called this the “most important pension news ever”. The Institute of Directors was with him. They called it the “most radical reform to pensions in decades.” And that’s not really an over the top interpretation.
It is, I think, really fantastic news for long-term savers. However, a good many people found an immediate problem with it. De Vere group, a provider of “specialist global financial solutions” calls the new deal “dangerous, ill conceived” and “short sighted.”
NOW: Pensions said that giving savers “complete freedom” in this way is “throwing the baby out with the bathwater”. And today, even the FT’s Tim Harford, who I like to think of as one of the most sensible men in money media, pointed to a future in which the papers would “wring their hands about some poor pensioner who blew his retirement savings on a boiler-room scam”.
The whole thing, say the critics, smacks of moral hazard: people will get their pension tax breaks, grab their money at 55, spend the lot and then expect the taxpayer to pick up all their bills from then on in.
This is nonsense. Complete nonsense. A few reasons: first, anyone who has saved up a reasonable amount in their pension would have to pay a whopping amount of tax if they took it all at once.
Say they had £400,000 at 65. £100,000 comes out tax free, the rest is taxed at the marginal income tax rate. So you’ll pay some at 20% but the vast majority at 40% or 45%. The total bill? £121,000. Who’d want that? Much better to stagger the take and pay more tax at 20% (or nothing) and less at 40%.
Let’s say you take £40,000 a year for ten years instead (I’m assuming no other income, no inflation and no returns, just to make the point). In the 2014/15 tax year your bill would be £6,000 and the total over ten years would be £60,000. Make it £20,000 a year over 20 years, and the total bill is down to less than £40,000.
Those who hold pensions aren’t idiots, likely to turn from diligent believers in the future to spendthrift short-termers on the turn of 55. They’ve saved this way to save on tax despite the disadvantages, so why would they abandon that principle now?
There’s more. Leaving your money inside your pension and taking it out as you need it means that your investments continue to roll up income tax and capital gains tax-free. That’s an amazing perk, and no one with half a brain – or in contact with an adviser with half a brain – would chuck it away lightly.
Let’s not forget that everyone is now going to get “guidance” before they choose a pension option*. Assuming it is good guidance, everyone but the truly desperate (or very unwell) is going to choose to enter flexible drawdown – keeping their money in a pension wrapper and using it to create an income. Note that the new system won’t limit the amount you can take out every year in the same way the current one does.
There are going to be some people who abuse the new system, but that won’t represent change: they are ones attempting to abuse it via pension liberation at the moment. For the rest of us, flexible drawdown and a new pension independence is about to become the norm. It won’t be long before we all think of pensions as nothing more complicated than a long term tax efficient savings account. And who wouldn’t want one of those?
*This is brilliant news by the way. Just-in-time financial education is the only type proven to work. See my blog on it here – one day I hope we will get the same guidance before buying a mortgage or a loan as well.