Posted in: Wealth Management Administration
First published on Finextra
The idea of Pensions ISAs was raised earlier this year; to make pensions more like ISAs where contributions are taxed but gains and withdrawals are tax free. This is opposite to the current pension system where tax relief is paid on contributions, gains are subject to a lifetime limit and withdrawals (excluding the first 25% and small pots) are taxed. However, the proposal seemed to have been dropped when it didn’t appear in the 2016 Budget.
However, over the summer talk of Pensions ISAs returned, with former Pensions Minister Ros Altmann voicing concerns that there is still a desire within the Treasury to make pensions into ISAs and warning of the dangers of such a move.
So are Pensions ISAs really as dangerous as some people have suggested?
I don’t think so. Critics of Pensions ISAs suggest that if pension contributions are taxed, the incentive to save for retirement disappears and pensions become much less attractive.
But taxation of pension contributions and the reduction of tax relief on withdrawals has been implemented in other countries and it did not mean the end of pensions. One example is Australia, where pensions are taxed on the way in, at 15 to 30% of the contribution depending on the individual’s tax rate. Pensions there are also taxed 15% on income earnings and 10% on capital gains, but not taxed on withdrawals. There are plans to change the Australian system: subject to legislation, from next July, the Australian government plans to introduce a $1.6 million cap on the total amount of pensions savings that can be transferred to a tax-free ‘retirement account’. However, this new measure does not affect the tax treatment of pension benefit payments.
The current UK pension system of tax relief at your nominal tax rate, is weighted towards higher earners, who are probably the ones who need the least incentive to save for retirement. A Pensions ISA system would be fairer, without penalising those who earn more or limiting gains made on savings. Another benefit of the Pensions ISA proposal is that younger people are far more likely to have an ISA than a pension, preferring their flexibility and simplicity to the more complex world of pensions. Capitalising on that engagement to encourage individuals to start saving earlier for their retirement makes a lot of sense.
Pension ISAs are also the logical conclusion of pension freedom. Taxing withdrawals from pension pots continues to place limits on what we can do with our retirement savings. By making withdrawals tax free, it gives individuals real freedom to choose how to spend their savings. Some critics believe that if withdrawals from pensions were tax free, people would have no hesitation in taking their money and splurging it all on that infamous Lamborghini. Undoubtedly some people would do that, as undoubtedly some have already done that under the current rules.
However, I believe that on the whole, people want to ensure their long term income needs are met. People desperately want clear information and flexible products combining investments, income and lump sums to give peace of mind through-out retirement as their needs change and evolve. That’s true pension freedom.