The pension freedoms announced by George Osborne come with the option to draw money straight out of your pension savings. This has led to commentators (and Government?) likening pensions to a bank account, with some going so far as comparing them to withdrawals from a cash machine.
Unfortunately, for now at least, pensions aren’t exactly like cash machines. Here are five reasons why not.
1. Not everyone will be able to draw their money out
With a current account, as long as you are in funds you should be able to withdraw your money. Pension customers can be in funds, but not be allowed to draw the money – an eligibility check is required.
Age is one such barrier. This could be a simple check to make - is the customer over age 55? – but this isn’t the whole story. Further investigation may be needed to check if there is a protected pension age or the customer is in ill-health.
Other criteria include whether there is any lump sum protection and whether there are any disqualifying pension credits. The former may require the customer to confirm the situation – not something to rush over in the same manner as dismissing the need for a receipt from the cash machine.
The solution is to allow 25% tax-free cash for all withdrawals, and have any difference resolved through the person’s personal tax returns.
2. Tax needs to be deducted at source.
If you ask for £200 from a cash machine, you expect to get £200 in crisp notes. Not so with a pension. Whilst a portion is tax-free, most is subject to income tax at the customer’s marginal rate of tax. So a £200 withdrawal may result in £170 in notes (a bit more problematic if the answer is £165.30). The actual amount will depend on the individual’s tax code and this prohibits quick assessment of the tax to be deducted at source.
Advances in technology, including at the Revenue’s end with Real Time Information, may make payroll a calculation that can be performed in seconds at some point in the future. For now, it generally isn’t and the Real Time Information system continues to throw up queries that customers might want to query rather than just accept.
Technology will catch up fast. Until then, a simple solution could be to give an option to tax the money at basic rate, and sort out the rest via the personal tax return.
3. Some people will have to pay an additional tax charge
The lifetime allowance (LTA) restricts tax-efficient pension saving that an individual can build up over their lifetime by imposing a tax charge once the individual has accessed substantial pension savings. This involves a running tally across all pension funds that the customer has.
The simple concept still requires a lengthy form that is irrelevant to the majority of the population and unengaging for the whole population. With the emphasis very much on restricting what can be put into pensions, one would hope the LTA is seeking out its own retirement.
Given the tax break afforded to pensions payable to dependants, it seems slightly churlish to persist with complex pension legislation to penalise those who may benefit from having invested their pension well. The LTA should be scrapped, or as an interim allow pension providers ignore it and have the charge collected via Self-Assessment instead.
4. A simple receipt won’t be good enough
Personal pension schemes are regulated products and with the advantages of increased consumer protection that comes from having a regulated product, you also get a wealth of information that providers are either required to give consumers, or feel obliged to, lest the regulator raises criticisms at a later date about insufficient warnings being given.
The regulator is still deciding on what information needs to be given for customers making these sort of withdrawals, and you might expect that it will be more than you would get on a receipt from a cash machine.
Whilst various warnings could be flashed up on the ATM screen, I suspect behaviour would be to click YES or NEXT without truly taking in what is being presented.
What’s the solution? A pension provider may want surety by issuing paperwork by post or by email after the transaction. The regulator needs to be on board.
5. You can’t always pay the money back in
Finally, bank accounts allow a flow of money out and in. Money going into a pension, however, is controlled by contribution allowances. So it isn’t really possible to draw money out and then change your mind. Customers need to know that when they take money out, it’s permanent.
The principle lying behind the new pension freedoms is that the public should be trusted to look after their own pension money, just as they are already trusted with their bank accounts and ISA savings. There is no warning at cash machines when you draw money out to think about what you will need in five years’ time.
You can see that the principle backing most of these issues really is that pension pots come with a pregnant tax charge. Simplifying the tax charges, and/or passing any variation from a standard tax position to the customer, would help speed up access and generally reduce the charges associated with pensions.