A-Day for dummies
Ross Clark says that the Chancellor’s simplified new pensions deal is not only confusing, but deceptive. The only people who will benefit from it are the accountants Next Thursday is A-Day, the day on which, according to the Department for Work and Pensions, the ‘new simplified rules on pensions come into effect, offering simpler and more flexible retirement arrangements’. If you haven’t got the hang of them by now, Her Majesty’s Revenue and Customs (HMRC) has produced a set of notes running to, er, 164 pages.
To put it even more simply than the HMRC can manage in that document: the government wants to give us tax relief on pensions in order to encourage us to save for our retirement. But it is concerned that by taking advantage of the tax relief we might become too rich, so it has devised a bizarrely complex new scheme to tax our tax relief.
The rules on pension funds are — presimplification — relatively simple. The money you pay into your pension fund qualifies for income tax relief at 22 per cent or 40 per cent, depending on your earnings. If you are aged up to 35, you can put 17.5 per cent of your gross annual earnings into your pension plan; a percentage which rises as you approach retirement. Come A-Day and the tax relief is being made, at first glance, more generous. From now on you will be able to pay your entire salary into your pension fund, up to a maximum of £215,000 in any one year, and qualify for tax relief on every penny. Yet because nobody pays income tax on every penny they earn — there being a personal allowance that is free from tax this will create a bizarre situation in which you could actually be making a profit from the taxman. However, you will have to be rather wary of taking up this unprecedented offer, because if your accumulated pension pot grows to a new ‘lifetime annual limit’ of £1,500,000, any excess will henceforth be taxed at a shocking 55 per cent.
This is the most punitive rate of personal taxation in Britain since the early 1980s, and it is not just the wealthy who will be affected. The sum of £1.5 million does not go far these days when it comes to buying a decent pension. For a male aged 60, for example, it will buy an annuity of around £45,000 — not much more than the £37,397 a year goldplated, index-linked pension which an MP qualifies for after 27 years’ service. Needless to say, there will be no question of MPs paying the new tax: theirs is a final salary scheme, paid directly out of public funds, so there is no pot of money to be taxed.
Moreover, it will extremely difficult to try to plan to avoid the new 55 per cent tax. How do you know, when investing £1,000 in some obscure Russian oil company, that its share price will not rocket, taking your pension fund above £1.5 million and liable to be taxed at 55 per cent? Neither can you reduce your liability to tax at 55 per cent by taking money out of your pension fund; once it is in, you cannot get at it until at least the age of 50, soon to be raised to 55.
If the Chancellor is so concerned about us making such profits tax-free, why give us such generous tax relief in the first place? Gordon Brown’s approach to pensions right from the start has been that of a daft old aunt who keeps handing out gifts and then asking for them back. One of his election promises in 1997 was to introduce cut-price ‘stakeholder’ pensions to encourage more people to save for their retirement. Yet one of his first acts as Chancellor was to abolish dividend tax credits on pension funds, hugely suppressing the rate at which share investments within a pension fund can grow. Then, three years ago, he came up with a scheme so generous that the accountants could hardly believe it: he told us that from A-Day we would be allowed to put wine, antiques and property into our pension funds. Moreover, unlike share dividends, rent from the properties within our pension funds would be tax-free. When it became clear, last December, that this would prove a very popular tax break, he suddenly withdrew the offer — but not before investors had signed up for, and in many cases paid deposits for, millions of pounds worth of property.
If he is going to keep changing the rules every five minutes, small wonder so few of us seem to want to lock up our money in pension funds for 40 years. In the year to the third quarter of 2005, regular payments into individual stakeholder pension schemes fell by 10.4 per cent. But even those who have taken out stakeholder pensions are contributing pitiful sums: according to one provider, B&CE Benefit Schemes, 170,000 of its 360,000 stakeholder pension schemes are receiving no contributions at all, and a further 160,000 are receiving only £2.50 a week.
Who can blame them? No matter how welcome the tax relief, ultimately we will be obliged to use our pension pots to buy an annuity — essentially a life assurance policy in reverse, which causes us to swap a large capital sum for the promise of a regular income for the rest of our lives. The problem is that with long-term interest rates falling and life expectancy soaring, annuity rates have halved in recent years, with the result that many workers have ended up retiring on half the income they had been expecting.
Annuities have become such an unattractive financial product that virtually nobody buys them any more unless forced to. ‘The market has fallen substantially in recent years,’ says Andrew Oliver of the Annuity Bureau, a broker for the industry. ‘People sometimes buy an annuity to cover long-term care costs for an elderly relative, but otherwise people hardly ever buy them unless they are buying them out of their pension pot.’ Gordon Brown has relaxed the rules on annuities a little: from next week it will be possible to convert your pension instead into an ‘Alternative Secured Pension’, a slight variation on an annuity which allows you for the first time to pass on some of your pension wealth to dependants. But a pension fund remains a very inflexible way to invest for your future. It might be better for everyone if the government simply abolished pensions altogether, and reduced taxes on all savings instead. The argument for pensions is that they reduce the dependence of the elderly upon the state. Yet, given the poor uptake of stakeholder pensions, it is clear that the tax breaks on pensions are mostly being seized upon by the well-off, who would be investing anyway. The poor continue to rely upon the state pension.
Pension tax breaks, according to Carl Emmerson of the Institute for Fiscal Studies, are worth £12.3 billion a year. This would be enough to reduce the basic rate of income tax by 3.75 pence, or to reduce tax by an even more substantial percentage on bank and building society accounts. These are a form of saving which everyone understands, not just wealthy people with clever accountants. Yet why, if Gordon Brown wants to encourage a savings habit, are they still taxed at 20 per cent?
Giving tax breaks on ordinary savings is, of course, far too simple a solution for Gordon Brown. As ever with his initiatives, the complexities introduced by A-Day are really just a form of targeted help for one hard-pressed group of people: accountants.
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