Here’s some thoughts I jotted down on what the new tax on lump sums comgin out of drawdown plans may look like. I wrote this a week or so ago, though I understand just now that a simepl flat rate is likley to be announced later today. I guess we’ll see but this was my thinknig including why a simple flat rate might not be in government’s plans:
Most commentators have picked up that government said 55% is probably too high. That doesn’t translate into the new tax being, say, 40%. There are lots of options compatible with the government’s thought.
1. Ok we could have a replacement lower flat rate of tax, but that would create opportunities for IHT sheltering in a pension. Fine with me! I’m not a fan of IHT as a way of collecting tax, but may not be fine with HMT
2. It could be a tiered rate of tax. Eg first 100k gets taxed at 40%, rest at 55%. If this sounds complicated to administer for pension schemes, don’t forget it it easy compared to Lifetime Allowance protection at retirement when there are multiple pots.
3. A rate linked to income tax. This begins to sound fair, as basic rate taxpayers have paid in with 20% relief and then would get taxed at 55% currently. To deal with IHT sheltering, it’s possible the answer could be 15% paid by pension scheme and income tax by Estate for example.
The abuse issue here (I go on about it as it’s a key part of creating policy and the rules around it) is that a higher rate taxpayer in last stages of life may purposefully reduce income to gain the system.
As such, a look back system may be needed. Eg higher rate taxpayers for any of last three tax years pay the higher rate.
Sounds complicated? Yes. But Labour managed it when bringing in the Special Annual Allowance. It was horrible to administer by the way.
4. A rate linked to IHT. Eg Fund is taxed at marginal rate of IHT. This sounds simple to explain, relatively fair and hard to abuse.
Would it be hard to introduce? Well, Labour managed it when we had the ghastly Alternatively Secured Pension rules form 2007 onwards when lump sum death benefits formed part of Estate.
Possible, but probably the most complex of pension rules I have ever come across.
So what’s my prediction. That’s hard – my vote would be simplicity via a flat rate or if necessary (and HMT will probably demand that it is) a tiered rate.
By the way, this reducing of tax would probably need to be funded so as to be tax neutral by another change in pension rules. Perhaps the tax free benefit on unvested pension funds? How to do that fairly is another debate.
I’ll leave you with two great articles by the busiest Bee I know.
UPDATE: Having read today’s document on the Government’s Response to consultantion of Freedom and Choice in Pensions, it seems that the new rule will be announced at Autumn Statement later in 2014, and may or may not be a flat rate.