Pension freedom customers face shock tax bills under Government plans

Unsuspecting savers that have taken advantage of the pension freedoms risk being hit by surprise tax bills under reforms set to be introduced by the Government in April
9 February 2017

The proposals create a cliff-edge where someone taking a tax-free lump sum can continue to save £40,000 per tax year but anyone who receives a taxable income under the pension freedoms sees their annual allowance drop 90% to £4,000.

As it currently stands, anyone who has accessed the pension freedoms via a taxable income in the form of drawdown or ad hoc lump sums has the amount they can contribute into a pension reduced to £10,000 a year by the Money Purchase Annual Allowance (MPAA). 

In its response to the Treasury’s consultation, AJ Bell is urging the Government to scrap its plans to reduce the MPAA and instead says it should look at introducing a system whereby anyone who has made a withdrawal from their pension – be it annuity, drawdown, taxable lump sum or tax-free cash – would be subject to a universal MPAA.

Pensions carry forward, where people can utilise unused annual allowances from three prior years, should be scrapped for those that have taken pension benefits, with the consequent tax savings used to boost the value of a universal MPAA.

This would simplify the system by making it consistent across all pension withdrawals and people would be more likely to understand it and hence avoid falling foul of unexpected tax charges.

Tom Selby, senior analyst at AJ Bell, says:

“It does not make any sense that someone who chooses an option where they pay tax on their withdrawal is punished hugely in comparison to the individual who chooses the tax free option.

“Given that most people won’t be aware of the plans to reduce the MPAA, there is a significant risk large numbers will accidentally overpay into a pension and be hit with an unexpected tax charge.

“This is particularly the case because everyone will be automatically enrolled into a workplace pension scheme with minimum contributions of 8% in 2019.  Many employers will offer higher contribution rates than this, meaning middle income earners could end up being hit with a shock tax penalty on their pension savings.

“The Government needs to stop tinkering at the edges and accept the current rules are not fit for purpose. It should shelve this unfair cut in pension savings incentives and go back to the drawing board so we have a system that works for savers as well achieving the cost savings the Treasury is aiming for.”

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