Govt restricts pension freedoms to prevent recycling

George-Osborne-BW-700.jpgThe Government is reducing the money purchase annual allowance for those who draw benefits, substantially closing a multi-billion loophole created by George Osborne’s pension freedoms policy.

The move, designed to close down the potential for recycling salary through pensions, avoiding employer and employee NI on £10,000 a year – and £40,000 in the first year – as well as saving income tax on a quarter of that figure, has been criticised as going against the spirit of pension freedoms.

In 2014 Corporate Adviser highlighted how Osborne’s pensions freedoms created the potential for employers and employees to cut the state’s tax take by over £3,000 for each £10,000 channelled through pension. Osborne’s policy allowed everyone over age 55 an extra £2,500 income tax allowance and £10,000 exemption from employer and employee NI – with four times this amount of relief available in the first year. At the time the Government denied any problem with recycling.

Corporate Adviser figures placed the potential loss if every UK worker used the loophole at between £20bn and £24bn. The Autumn Statement documents say only 3 per cent of people are making pension contributions of over £4,000 a year, and estimates it will recoup £70m from the policy. However, it never published substantive research into the likely impact of the loophole, and some industry insiders believe it had not spotted the potential tax leakage when the pensions freedoms policy was unveiled.

Hymans Robertson partner Chris Noon says: “The Government is clearly trying to stamp out recycling pension savings – whereby people could get a double hit of pensions tax relief by withdrawing money from their pension and then re-investing it. This policy could be a disincentive to flexible working at a time when we should be doing more to support it given increasing pension savings shortfalls. ‘Retirement’ is no longer a cliff-edge event. It’s a process over many years.

“As we see a shift of more people retiring with DC than DB pensions we’ll see more people unable to retire early. But for some, working full time into later years will be a struggle – either for health reasons or because they have care responsibilities. The government should be doing all it can to support that.

“Let’s take the example of a 57 year old earning £50,000 per annum full time and they’ve already taken advantage of the 25 per cent tax free lump sum. They decide to reduce their hours to a 3 day week bringing their earnings down to £30,000 and they decide to withdraw money from their pension to supplement their income. If we assume they have total contributions of 15 per cent into their pension – a combination of theirs and their employer’s contribution – that equates to £4,500.  What this means is people will either be deterred from withdrawing from their pension or they’ll stop saving into it. This is antithetical to the philosophy of pension freedoms, as well as unsupportive of flexible working. The level is too low.”

Prudential head of technical Les Cameron says: “The Chancellor’s intention to reduce the Money Purchase Annual Allowance is probably the biggest pension announcement in the Autumn Statement. The government has to strike a balance between reducing the number of those able to claim tax relief twice while keeping a limit workable with auto enrolment.  The consultation on the subject, which the government published alongside the Autumn Statement, confirms that less than 3 per cent of over-55s have defined contribution payments of more than £4,000 so it will apply to a subset of these who have also flexibly accessed their benefits.  These people will need to take action to reduce their contributions. The question for advisers is whether clients should reduce the contributions and save elsewhere or turn off some of their pension income.”

AJ Bell head of technical resources Gareth James says: “The proposed cut in the MPAA to £4,000 is likely to be relevant to a tiny number of savers and it is difficult to see how the Government is going to raise anywhere near the £70m a year it anticipates.  The consultation document points out that only 3 per cent of individuals aged over 55 make pension contributions of more than £4,000 a year and our experience is that the number of people who have used the pension freedoms that make those kind of contributions is even lower.  It will be interesting to see whether the Government proceeds with this proposal once it has heard representation from the industry about the limited impact it is likely to have.”