We should cut pension allowances further

One of the most forecast elements of the Autumn Statement was that there would be a change to pension allowances. And so there was. The lifetime allowance was cut to £1.25m (down from £1.8m only a few years ago) and the annual allowance was cut to £40,000 (down from its original £255,000 and current £50,000).

There hasn’t been that much general complaint about this. That’s probably for the simple reason that most people who can afford to put that much in their pensions in the first place know perfectly well that they shouldn’t be going on about it in this kind of environment. If you had a good enough final salary pension in the public sector that this hit you with a tax charge would you consider now a good time to mention it? Quite.

The fact is that over 99% of the population make pension contributions of well under £40,000 a year, if they make any at all.

There has been a little huffing and puffing about the annual allowance cut not being fair on entrepreneurs, who might make their money in lumps and so not get the chance to build up their pots as much as other people. But given the generosity of entrepreneurs’ relief (tax at 10% on your first £10m of entrepreneurial gains) most small businessmen have tended to keep their mouths shut on this one too.
 
It is also the case that cutting these allowances makes perfect fiscal sense. As Michael Johnson points out in the FT, pension relief is stunningly expensive to the taxpayer.

The relief on contributions in 2010/11 came to £26bn; that on employer National Insurance contributions came to £13bn; tax forgone on the 25% lump sum we all get to take on retirement came to £2.5bn; and that forgone on investment income came to £6.8bn. The total? £48.4bn.

That’s real money. So much so that it “equates to the combined budgets of the Home Office and Departments of Justice; Culture Media and Sport; Environment, Food and Rural Affairs; and Energy and Climate Change. Worse, almost 50% of this money goes to those making more than £50,000 a year – who are using it mostly as a method of tax planning or deferral.

Look at it like this, and you might start to think (as I do) that even at their reduced levels the allowances are still far too high. After all, the whole point of the pension relief is to encourage people to save so that they are not a burden to the state in their old age.

How much of a pension prevents you being a burden? The government has already told us the answer to that question. The minimum income requirement for flexible pension drawdown is £20,000 a year. So it makes sense to think that £20,000 is the number they have in mind.

So what kind of pot would generate income of £20,000 a year, which would then give us the ‘correct’ lifetime allowance? Capitalise £20,000 at 4% and you get around £500,000. If you must keep pensions at all (regular readers will know I would prefer to dump them entirely in favour of an expanded ISA system) there’s your lifetime limit. Any number above that is just odd.

If I were a politician determined to keep, but also to control, the pensions system (small mercies that I am not) I would cut the limit to that immediately; put a one-off tax on any assets above it and be done with it. I’m guessing the actual politicians have done the same numbers but plan to get to the end game a little more slowly – helped along the way by a little fiscal drag and a whole lot of inflation. We’ll see.
 
The real complaints about all this are coming from the likes of the Telegraph’s planned Hands Off Our Pensions campaign – which calls on politicians to stop making constant complex changes and stop treating pensions “like a piggy bank”.

But these complaints miss the vital points in the saga of subsidised pensions. The first is that fiscal default doesn’t have to actually mean not paying back actual debts. The term can also cover a government’s default on its implicit promises to its electorate. That’s what ‘austerity’ is all about.

The second is that in a time of crisis – barring total social and political breakdown -  the government can indulge in financial repression, be that keeping interest rates always below inflation; forcing pension funds into sovereign bonds; or just taking back some of the subsidy they once put into your SIPP  – and that there is nothing we can do about it. Why? Because they are in charge. That’s what sovereignty means.

29 Responses

  1. 10/12/2012, Boris MacDonut wrote

    Very good article Merryn.I concur with 98% of it. One niggle is the conflict with what Phil Oakley told us only 3 days ago.
    His article on comfortable retirement used some clever and accurate maths to show that a pension pot of £517,000 buys a pension of £30,000pa. You say a pot of £500,000 will buy £20,000. So who is right? Or should I take the Boris average and assume that £508,500 will buy £25,000?

  2. 10/12/2012, Romford Dave wrote

    I’ve reworked Phils’s figures Boris, to bring pension affordability to more of the masses, back of a fag packet stuff so no need to bring your exacting eye to bear.

    I’d go further Merryn, Duncan (a fellow poster) raised a good point the other day when he highlighted the privileged many whose gilt edged pensions put us mere hoi polloi to shame with our paltry pension pots.

    Anything over £500k should attract the 55% immediate deduction the man from HMRC demands on ours.

  3. 10/12/2012, Boris MacDonut wrote

    #2 Dave. You mean guilt edged.

  4. 11/12/2012, Shinsei1967 wrote

    Boris

    I’m guessing that a £500k pension pot buys you an index linked £20k pa sum or a £30k non-index linked sum.

  5. 11/12/2012, Critic Al Rick wrote

    Boris

    I’m interpreting that £500K invested in FR Bonds gives you £20K/annum in interest and, if you’re very careful, an inheritance for your offspring.

    Whereas the investment giving you £30K/annum leaves nothing for your offspring.

    What suits one depends upon how selfish one is.

  6. 11/12/2012, Boris MacDonut wrote

    #4 Thanks. Back of the fag packet maths suggests I can retire from the Jam Quarries in 3 or 4 years then. Imagine how much more time I’ll have to analyse MW posts in depth.

  7. 11/12/2012, Romford Dave wrote

    I wondered what that big cheer was that emanated from the direction of Blackfriars Road just before quarter past five!

    The MW staff must be pleased at your impending retirement :)

    Still persisting with numbers to identify posts though. Have you seen what happened to your #51 on the corporation tax page?

  8. 12/12/2012, ReactiveNonsense wrote

    Why the sudden desire to pay more tax? You lot weren’t standing outside Starbucks recently by any chance?

    If you want to march up Whitehall shoving YOUR £50′s in the pockets of every civil servant you see, be my guest but don’t tell me I should do it with my cash.

    So, Merryn, why use ISAs? I mean, they’re a tax break and what you’re saying here is that there is some kind of “moral wrongness” to using tax breaks if you have a lot of money?

    If tax reform is really the aim then propose something concrete and lobby to get it accepted – this Daily Mail type cheerleading is one of the reasons I stopped subscribing to MoneyWeek.

  9. 12/12/2012, Edoardo wrote

    Hi, my wife and have contributed to a pension fund (Standard Life from 1995) and our own SIPP from 2006 to date. Although our contributions have been small, our fund is now near the £500,000 value.
    I do agree to limit annual contributions however I’d think unfair to set a limit on the total value of the fund.

  10. 12/12/2012, Radical Eye wrote

    Merryn
    Normally, I appreciate your views, but this time you are fiddling round the edges and you start with a non-sequitur.
    Tax relief is not tax foregone. Remove the relief and you will dramatically reduce pension contributions. Just as raising tax rates often reduces tax revenue remember Laffer.
    Short term Government dis-incentivises saving in the vain hope that spending our piggy banks will create “growth”. Journalists such as you, Merryn, should focus on the real problem – too much Government.
    The UK needs a dramatic reduction in State expenditure. Salami slicing gets nowhere. Surgery is needed.
    For starters, abolish Corporation Tax, but compel companies to pay 50% of their profits as dividends. Abolish National Insurance. Abolish the DVLA and replace with an Insurance Industry Register. Make all benefits taxable. And that is before lunch!
    A return to prosperity can only come through such radical ideas. The alternative is street violence and Golden Dawn.

  11. 12/12/2012, Boris MacDonut wrote

    #8 it is not a desire to pay more tax. Just to get Companies top pay a fair share. When and if they do the rest of us ordinary individuals can pay a bit less.
    #10 R Eye. How absurd. Taxing benefits creates a dual layer of bureaucracy. However ,I do agree NI has had it’s day and Gideon has parked the issue rather than seize it. Another vote loser for the Eton toffs.

  12. 12/12/2012, clive chafer wrote

    Absolutely right on higher rate tax relief, Merryn. Surely best to leave an incentive for basic rate taxpayers to help them to look after themselves in old age by giving tax relief at 20% but give top rate taxpayers exactly the same incentive i.e. tax relief at 20% NOT 40%. It would be fair and would bring in some valuable money to get this deficit down, as long as the government doesn’t waste it on unnecessary new ‘initiatives.’

  13. 12/12/2012, Romford Dave wrote

    Clive, if that’s the extent of the incentive on offer, pensions will wither on the vine.

    Why would anyone forfeit the 20% tax rate and risk whatever the chancellor of the day deemed appropriate at some future date?

    33% basic rate tax has been the norm in the not so distant past, I distinctly remember a much lightened pay packet, so I’d definitely avoid contributing to that scheme.

    Your suggestion would be the death knell of the pension industry, not necessarily a bad thing but not in keeping with incentivising saving for old age.

  14. 12/12/2012, Blackfordian wrote

    Agree with Romford Dave – it too often gets forgotten that future pensions are taxed in payment, but at what rate we can only guess.

    Merryn has swallowed the line that tax relief is a subsidy – it ain’t, its simply being allowed to keep more of your own money. And do you seriously think there will be any pensions still available for basic rate taxpayers, once all the higher rate taxpayers stop contributing?

  15. 13/12/2012, David Webb wrote

    Merryn, you chose to use 4% interest to work out £20K needs a lump sum of £500K. But as the income drawdown is limited to 6.36% of a pension, a £500K pension could be used to finance income drawdown of £31,800 a year. Annuities are a con – and so is interest really – the best option is to keep your money invested and use income drawdown. £20K of income drawndown requires a lump sum of £314,465.

    I agree that the pensions should go entirely – this business of locking people’s money up for decades is ridiculous. It is only because we have convinced people the state will provide for them in their retirement that the state has a problem encouraging people to provide for themselves.

  16. 13/12/2012, David Webb wrote

    I would go Chinese – and in China it is illegal to refuse to support your aged parents and it carries a 2-year prison sentence. Unfortunately, in the UK, many people are “estranged” for their families – and so the state is their family, so to speak. By encouraging family breakdown (divorce, novel family arrangements, unmarried motherhood at state expense, etc), we have gone out of our way to create a situation where many people have no family to fall back on. I personally don’t want to finance other people’s parents’ nursing care – we need to rebuild the family as the only way for the state to get out.

  17. 13/12/2012, Dave wrote

    The thing you are missing Merryn is that the UK government is trading the thin line between inflation and hyperinflation and using QE as a stealth tax on pensions. So as well as having our pensions stolen by QE, you will find a hell of a lot more people than you think affected by these measures. The broke government will rob whomever they can to pay the bill. I would expect you to be promoting a balanced set of books for UK PLC by spending less rather than taxing more. When we all switch to ISA what do you think they will do next?

  18. 13/12/2012, John Berrisford wrote

    I totally disagree with Merryn’s seeming agreement with the Government using pensions as a political football. If we are to have a ‘Lifetime Allowance’ then once decided at 1.8 million a few years ago, it should be retained or even increased a little to allow for growth and inflation, not reduced every time we have a budjet. Surely the idea of saving for a pension is to ultimately end up with as big a pot as possible to provide for oneself and family till one hopefully reaches a 100 (unknown parameter)
    Merryn says she thinks ‘forget pensions and use ISAs’.Yes, I think ISAs should be a part of retirement planning, but what happens if existing or future governments use the politics of envy to put a ‘Lifetime’ limit on these as well, in retrospect as they have done on pensions. They encourage people to save, then steal the money for themselves. GREAT

  19. 13/12/2012, Merryn wrote

    @John Berrisford. I’m not saying that fiddling with the pension system is a good thing or a bad thing in itself. Just that it is an inevitable part of repression and fiscal failure. Because pension pots hold as yet untaxed money the government can do as it likes with them. And if you think about what it makes sense for them to do it seems obvious that the allowances will continue to be cut. So it makes sense for us to limit the amount we put in our pensions.

  20. 14/12/2012, steve wrote

    Why is the government so anti marriage. What happens to the rare few who have been married for 40+ years and love their family but have one wage, thus one pension to share. Surely the government encourage them to save and have a larger pension pot.

  21. 14/12/2012, Steve wrote

    What utter socialist garbage. If you are hard working enough to make enough money to exceed the lifetime allowance then good for you. What utter tosh to say that pensions relief costs the exchequer. It costs them nothing – they never earned the money in the first place and have no right to take any of it away. Taxation of income is robbery pure and simple – taking peoples money away from them at any arbitary rate with the promise of violence to back it up. Note that taxation is optional if you are a global multinational or a non-dom. The whole system is immoral. Good job I am still on the 3 week trial if this is what passes for journalism on MoneyWeek.

  22. 14/12/2012, 4caster wrote

    The posts I like most are #16 and #20.
    £20,000 per annum might be enough to keep the main breadwinner, usually male, in a decent standard of living (if index-linked). But to keep a wife too, who may have taken two or three decades out of the workforce to raise a family, denying herself much of a pension, requires £30,000 to £40,000. (And we need high earners to have families, not just those who live on benefits.)
    Then there are people like writers or actors whose lifetime earnings are very erratic, who will sensibly want to save vast sums in the good years, so as to provide a (taxable) pension later. Why should society discourage that form of financial planning?
    Merryn, your advice (#19) to individuals to diversify savings away from pensions, because they will be raided by the government, seems very sensible to me. But in the paragraph beginning “If I were a politician ….” you make it clear that you too would cut the tax-free limit on contributions.

  23. 15/12/2012, David wrote

    Facts should prevail.
    Fact The UK is spending more than it earns.
    Fact The UK is in a massive debt hole and it’s increasing.
    Fact The only long term solution is to spend less and earn more.
    Fact This can be achieved but the politicians are too compromised.
    Fact It is now time to act on the Facts before the Facts act on us all.

  24. 15/12/2012, oggiemaker wrote

    Two things. (1) People should save to provide a source of investment for things we need but governments don’t make the the investment bit happen as Gordon Brown talking about investment when he meant consumption or even waste. (2) All governments have lured people into saving for pensions (a) LAPR (remember it?) scrapped (b) SERPS changes some retrospective like halving the widows’ benefits (c) the Equitable scandal (useless regulator and disregard of Ombudsman’s ruling (d) the Brown pension raid (e) the NORTEL scandal where the pension fund was transferred to a company none of us had ever worked for, taken overseas and lost. Those have cost me several thousand a year: Mrs O-M and I won’t starve but if the ministers who did all this had been company directors you Merryn would have screamed for thoer disqualification or even stone breaking on Dartmoor. What all this does is breed a world of mistrust where nobody believes anybody any more: my word is my bond forget it!!

  25. 17/12/2012, Will Grumpy wrote

    Goal posts should not be retrospectively moved. What if you’ve worked hard to build up a pension & your fund will breach the new level ? Suddenly you’re hit (on retirement) at 55% ,which is not what you were told when you started. If you’d known this at the outset ,you would not have put the money into such an inflexible investment.We must be able to plan.

  26. 17/12/2012, michael j meadowcroft wrote

    There should also be an impact on final salary pensions. Using your arithmetic any civil servant with an index linked pension of over £50K should be paying additional tax on the extra. They might of course agree to a reduced pension entitlement instead!

  27. 22/12/2012, Boris MacDonut wrote

    #26 Michael.People reading this might think it involve a lot of civil servants but no. The only civil servant likely to get a £50k pension would be in pay band 3 of the Senior Civil Service and with at least 36 years service. Pay band 2 has a median pay of £80,000. Pay band 3 has just 900 members with a median pay of £120,000 and average length of service at 27 years. They account for just 0.16% of the civil service staff and 0.8% of the pay bill. These details are freely available from the SSRB from 2011 and it seems just a couple of hundred individuals would trouble the scorer with a £50k pension. Try turning your ire on the banks.

  28. 23/01/2013, Ian from across the road wrote

    I favour encouraging people to save and be self-sufficient. Limiting pension relief will just encourage the “welfare entitlement attitude”. Far more important is for the government to stop spending so much. They have done this in Ireland to a certain extent with encouraging results but our politicians think first of doing the populist thing in order to get re-elected rather than the right thing – not just to reduce the deficit, but to eliminate the national debt. We are all on the road to Carey Street if attitudes don’t change – and soon!

  29. 24/03/2013, Level Paying Fields wrote

    The government(s) suggest that the less privileged should be helped to have a more sustainable lifestyle.
    To do this they ( amongst other initiatives ) play with the Pension system.
    It would be interesting if they treated themselves the same as tax payers. I acknowledge that there are a minimal number of civil servants ( and MP’s ) who will receive pension fo +£40 k per year. Their life time limits are calculated at pension pot x 20. The reality for the tax payer is that if we were to apply the same logic we would need to use life time limit divided by 33.
    The end result, for the same life limit they will receive a pension approximately 33% larger than the average tax payer.
    It just goes to show that for some there is no cost of failure

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