Think tank urges government to cap tax-free lump sums at £40,000

Holly Roach reports...

Capping the pension tax-free lump sum at £40,000 would raise £2bn a year for the government, new research by the Resolution Foundation suggests.

The think tank said tightening up inheritance tax and removing expensive wealth subsidies would also save the government money, and suggested a small change would reduce the maximum generosity of the tax-free lump sum.

The report states the current ability to take over £250,000 tax free, is worth up to £119,000 to an additional rate taxpayer, £105,000 to a higher rate payer, and £53,000 to a basic rate payer, but nothing to lower income pensioners.

The think tank said in a statement: “That’s very generous, very regressive, and a strange incentive not to stagger your retirement income.”

It suggested the current sum is overwhelmingly benefitting higher earners.

Barnett Waddingham senior consultant Malcolm Mclean was sceptical about imposing a cap. “The right to take 25% of your pension savings as tax-free cash is a long-standing and much-valued part of an approved pension plan.

“The proposal would almost certainly receive a hostile reception from consumers and create some horrendously complicated transitional arrangements to give effect to past accrued rights.”

The £40,000 cap would supposedly leave three quarters of future pensioners unaffected.

Mclean continued: “The only situation I could see as warranting some form of capping would be as part of a package of tax relief reform which gives rise to the scrapping of the lifetime allowance limit as a sort of quid pro quo. But even in that situation I think any cap would have to be higher than £40k and the full political and operational consequences carefully through before implementation.”

‘Wealth tax’

Currently, pension pots are free of inheritance tax implications if they are passed on, and with the introduction of the pension freedom reforms, individuals are able to hold pension pots through their lives rather than being required to buy an annuity with them. The report suggests this must be changed before huge costs are incurred from people spending all other assets before touching their pensions.

Willis Towers Watson senior consultant David Robbins said: “It’s similar to a kind of wealth tax, but one which would only apply to pension wealth where tax-free cash had not already been taken.

“It’s retrospective in the sense that it changes the tax deal that people were told they would get when they decided to save in a pension, which can’t be good for trust in pensions.” He added: “Some might stop saving if they did not believe the tax-free incentive would still be there when they retired.”

This report comes after the Liberal Democrat party passed a motion pledging to cap tax-free lump sums at £40,000 under Freedom and Choice, if elected into government. Their plan is to reduce tax advantages for high earners.

Henwood Court managing director Nicholas Platt added: “The reduction of the lifetime and annual allowances has already reduced the size of the tax-free cash and its true impact will be felt by those retiring in the next 10 to 20 years with significantly reduced pension pots.

“A further attack will not only be unfair, but hugely detrimental to the retirement plans of many that have planned to draw the tax-free cash.”

Platt went on to say: “We should be encouraging not discouraging people to provide for their retirement, particularly when considering the potential massive impact funding care costs will have on many in their later retirement years.”