Home > News > 2007 > February 2007 > Pensions after 75 - a tax on prudence
Pensions after 75 - a tax on prudence
In this article, which first appeared in January edition of Pensions Age, Adrian Waddingham discusses the effects of the Pre-Budget Report on Small Self Administered Schemes and Self Invested Personal Pensions.
We have all heard that the two certainties in life are death and taxes. Until December's Pre-Budget Report (PBR) though, members of member-directed pension schemes (more commonly known as SSAS - Small Self Administered Pension Schemes and SIPPs - Self Invested Personal Pensions) didn't know that death was to be "unauthorised" under the Finance Act, and so would result in substantial financial penalties! Experience on over 3,000 such schemes tells us that the latest amendments to the Finance Act 2004 are counterproductive. Certainly they mean that the new tax regime is anything but simple!
A very popular feature of the April 2006 pensions tax reforms (introduced by the Finance Act 2004) was the removal of the compulsion to purchase an insured annuity before a member's 75th birthday. It was always absurd that at 75, a member was deemed suddenly to lose the ability to manage his own investments, and forced to hand control of his savings to an insurer. Insurers are obliged to invest their annuity assets in gilts, and current low gilt yields and improving longevity mean annuity rates are expensive. Insured annuities deny a member the option to invest in more dynamic assets to improve his pension, albeit subject to risk, so Treasury's relaxation in the original Finance Act 2004 proved most welcome. For example, a scheme invested in property yielding 8% would no longer be forced to sell up at age 75 in return for a smaller insured pension. However, the Treasury subsequently tried to restrict access to this new flexibility to those with real religious objections to annuities (principally the Plymouth Brethren), and when they failed, as if in pique, the December Pre-Budget Report U-turn made the situation worse for all - including the Revenue themselves!
Until that unfortunate Pre-Budget Report, members were to be able to retain investment control in retirement, even after 75, and on death, any remaining pension funds could be reallocated to other members, albeit subject to Inheritance Tax. This is called "Alternatively Secured Pension" (or ASP). The Treasury were to do well out of ASP: not only did they receive income tax on the pension, they eventually got inheritance tax on the funds remaining on death. Furthermore, the member "inheriting" the pension had less scope for tax relief on future pension contributions because of the received funds. Now, the effective tax rate on remaining pension funds on death will be 70% and more: perverse since the effect is meant to drive people back to insured annuities where the Treasury's take on death is effectively zero.
People who save hard for their retirement resent the capital being lost on death. The Treasury is misguided if it believes that people will buy insured annuities - currently giving an income of about 5% per annum - unless they absolutely have to. Members were quite content under the original proposals that tax at 40% would have been payable in return for their family having use of any remaining capital on death. This seemed equitable. However, despite the extra tax take under ASP, the Treasury have now decided that 40% inheritance tax was "tax avoidance", but have failed to explain how this could possibly be the case. It can only be for old fashioned political prejudices, that Gordon Brown saw the new flexibility as a "tax break" for the rich, and so decided to cut off his nose. Taxes on death of 70%, and even 90% (the sums are, naturally, complicated) brings back memories of Denis Healey.
The PBR bombshell could backfire! Last year, around this time, the same Treasury was concerned about the "tax avoidance" that might happen if a member reallocated funds to his family during his lifetime. So tax at 55% was imposed on this in the Finance Act 2005 (before the Finance Act 2004 even came into force).
Now we find that this 55% tax on lifetime transfers is less than the 70% or 90% payable on death, so it does not take a genius to work out that members will be tempted to follow the path of least taxation, and reallocate funds to their family while they are alive. This will reduce the tax take from income tax, because pensions will be lower, and it will reduce the tax take from inheritance tax because funds will be smaller. This will achieve the opposite of the object of at least one of the anti-avoidance measures! What the Treasury are now giving us are not the pensions simplification proposals we all signed up to when we first saw them in 2002. How sad that for no apparent reason a door has been closed.
Barnett Waddingham LLP, February 2007