Simplification is the key - Centre for Policy Studies

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Figure 4: Income options upon retirement 56 On drawing benefits From 50 (55 from April 2010) & before 75 Tax free cash If tax free cash has not been taken by age 75 the option to take tax free cash will be lost. Unsecured income Minimum drawdown from £0 up to a maximum of 120% of GAD rates. Limit checked every 5 years. Short-term annuities possible. Can purchase a lifetime annuity at any time. No Income Remaining fund must be taken as a taxable income Yes Purchase an annuity (from a DC scheme) or draw a scheme pension (from a DB scheme)? Yes Over 75 Reach age 75 Purchase a lifetime annuity? Yes Annuity Fund used to buy an annuity No Alternatively secured pension (ASP) Minimum drawdown from 55% up to a maximum of 90% of GAD rates (always at age 75). Limit checked every year. See above regarding the tax free cash position. Can purchase a lifetime annuity at any time. At first sight, having to choose between only two different ways of realising assets to generate income in retirement appears relatively straightforward. The choice is between either a lifetime annuity or unsecured income, potentially leading to an alternatively secured pension (ASP) at 75. But there is a wide variety of annuities to choose from (see Appendix III) and they lack flexibility; for example, it is either impossible, or very expensive, subsequently to switch the form of income stream, or to switch between single life and joint lives. Alternatively, if the saver elects for unsecured income, there are a number of potential tax traps, the most serious of which is a potential 82% tax rate on residual ASP assets (see Section 2.5). But why are life funds and pension funds taxed differently? The simple answer is that successive governments have chosen to reward long-term pension saving by offering a gross roll-up regime (“middle E”), whereas life policies are generally accessible at any time. 2.5 Settling an estate after death Even after the saver has died, the complexity continues (see Figure 5). There are at least three different tax regimes impinging upon pension assets in respect of settling an estate, depending upon the timing of death, whether or not any post-retirement income had been taken before death and, if so, the form of income (unsecured income or an ASP). 56 With thanks to St. James’s Place Wealth Management Group. 17
Figure 5: Settling an estate after death 57 Death before retirement • The whole fund can be paid as a lump sum. Any excess over the SLA* will be subject to the Lifetime Allowance Charge of 55% • Any part of the fund can be used to provide a taxable dependant’s pension (if the excess over the SLA is used in this way it is not subject to the Lifetime Allowance Charge) * Standard Lifetime Allowance £1.8m from April 2010 to 2016. Form of income in retirement Alternatively Secured Pension Unsecured income Lifetime annuity Death after retirement No lump sum. If any dependants, fund must be used for taxable dependant’s pensions. Any dependants? Yes Yes Member aged 75 or over on death? No Lump Sum: Whole fund can be paid as lump sum, less 35% tax Dependant’s Pension: Can use any part of fund for taxable dependant’s pension. Once an income has been taken it cannot be converted to a lump sum at a later date. Lump Sum if Annuity Protection chosen: Purchase price of annuity less income payments received, taxed at 35% Dependant’s Pension: If dependant’s pension or Guarantee period selected at outset. No Dependant’s pension Yes Dependant aged 75 or over? No Purchase a dependant’s annuity? Yes No Continue with unsecured income. Amounts based on dependant’s age. Dependant dies before age 75. Yes Lump Sum: Remaining Fund can be paid as lump sum, taxed at 35% Dependant’s Annuity: Can use any part of fund No No for taxable dependant’s pension. Yes Any remaining Once an income has been taken it cannot be Purchase a dependant’s annuity? dependants? converted to a lump sum at a later date. Yes Result Residual Fund Donate to charity (no tax) OR transfer lump sum death benefit, subject to pension tax charge of 70%. Remaining 30% to estate, potentially subject to IHT No Fund used to buy an annuity The tax treatment of an ASP can be particularly tough. Many of those who elect for an ASP will previously have had an unsecured income, in which case, depending upon whether they die before or after reaching 75, their tax treatment is very different. If the former, their estate suffers a 35% tax charge (and had they had uncrystallised pension funds, then usually the full fund is payable as a lump sum with no tax due, including Inheritance Tax). However, if they die after reaching 75 without a spouse, 58 the tax rate on residual ASP funds can be as high as 82%, 59 the consequence of a cat’s cradle of provisions crammed into the Finance Act 2007 60 and the Inheritance Tax Act 1984. 2.6 The “cliff edge” at age 75: more uncertainty As we have seen, the age of 75 marks a watershed for pensioners, requiring a decision in respect of compulsory annuitisation or an ASP. It also exposes the saver to timing risk and creates uncertainty in respect of the taxation of unused pension savings. Consequently, the age of 75 is an arbitrary, discriminatory and penal “cliff edge” which runs contrary to what the Government should be doing: actively encouraging pension 57 58 59 With thanks to St. James’s Place Wealth Management Group. If the estate exceeds the nil-rate band for inheritance tax (IHT) of £325,000 (2009-10), doubled for couples (care of the automatic transfer of spouses’ allowances). See the Glossary for detail (under Alternatively Secured Pension). 60 Paragraph 69 and Schedule 19. 18
Page 1 and 2: Simplification is the key Stimulati
Page 3 and 4: THE AUTHOR Michael Johnson trained
Page 5 and 6: A note concerning data Finding a co
Page 7 and 8: These proposals depend upon having
Page 9 and 10: SUMMARY The UK’s long-term savin
Page 11 and 12: any annuitisation requirement, prov
Page 13 and 14: Thus, had pension savings products
Page 16 and 17: INTRODUCTION There has been a flood
Page 18 and 19: PART ONE: THE LONG-TERM SAVINGS LAN
Page 20 and 21: Japan’s savings ratio was once th
Page 22 and 23: scheme contribution rates are lower
Page 24 and 25: Table 1: Funded pension scheme asse
Page 26 and 27: 1.9 The international perspective A
Page 28 and 29: Table 4: ISA savers’ income distr
Page 30 and 31: Table 6: The complexity of the tax
Page 34 and 35: savings by delivering a framework t
Page 36 and 37: Figure 7: When non-savers might sta
Page 38 and 39: There are other aspects to consider
Page 40 and 41: 3. THE EMPLOYERS’ PERSPECTIVE 3.1
Page 42 and 43: When employees with DC funds retire
Page 44 and 45: More specifically, employers are no
Page 46 and 47: Both businesses do have important c
Page 48 and 49: year. 91 Clearly, there are conside
Page 50 and 51: elderly and the wealthy, not least
Page 52 and 53: 5. THE TREASURY’S PERSPECTIVE 5.1
Page 54 and 55: Whilst the UK’s NRR for the mean
Page 56 and 57: Currently, reducing pensioner pover
Page 58 and 59: Table 13: Net cost of tax relief un
Page 60 and 61: TEE would be hugely attractive to p
Page 62 and 63: 5.6 Tax treatment: international pe
Page 64 and 65: PART II THE PROPOSALS AND THEIR IMP
Page 66 and 67: Proposal 6: post-retirement, amend
Page 68 and 69: 7. TAX SIMPLIFICATION: SOME OPTIONS
Page 70 and 71: 8. THE IMPLICATIONS FOR SAVERS Impl
Page 72 and 73: The higher rate taxpayers’ perspe
Page 74 and 75: segregated from any employer-sponso
Page 76 and 77: epresent a further step down the pa
Page 78 and 79: 10. THE IMPLICATIONS FOR THE PENSIO
Page 80 and 81: Such principles would have to ensur
Page 82 and 83:
Figure 13: The cost of pension savi
Page 84 and 85:
pool of underlying pension assets (
Page 86 and 87:
hardship” facility, whereby cash
Page 88 and 89:
occupational pension scheme benefit
Page 90 and 91:
CONCLUSION We would save more, for
Page 92 and 93:
ACKNOWLEDGEMENTS This paper was cat
Page 94 and 95:
APPENDIX I Summary of proposals fro
Page 96 and 97:
APPENDIX II Value of assets in priv
Page 98 and 99:
depending upon age at the time that
Page 100 and 101:
APPENDIX V PRE-RETIREMENT ACCESS TO
Page 102 and 103:
APPENDIX VII FINANCIAL PLANNING TOO
Page 104 and 105:
APPENDIX VIII THE MODEL 173 The
Page 106 and 107:
GLOSSARY Alternatively Secured Pens
Page 108 and 109:
pensions and earnings, but excludes
Page 110 and 111:
those with earnings above £4,940 b
Page 112 and 113:
in cash terms, i.e. fixed at £770
Page 114:
The UK savings industry is barely t
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Simplification is the key - Centre for Policy Studies

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