The Institute of Economic Affairs (IEA) has called on the UK government to scrap the 25% tax-free cash allowance for pension pots and use the money to reduce or even eliminate inheritance tax.
Director general of the IEA Mark Littlewood said in a column in British newspaper The Times: “A meaningful reduction in certain rates of tax — or a hike in the thresholds at which they become liable — might be seen as more palatable if they go hand-in-hand with stripping away certain schemes which tend to benefit the more affluent.
“There is very little to justify the tax-free lump sum people can withdraw from their pension pot. Putting an end to that carve out could, for example, go alongside reducing or eliminating inheritance tax.
“In very broad terms, the burdens and benefits are both felt by the same demographic. Simplifying the tax system should involve taking rather less with one hand, while giving out less with the other.”
Drawdown or go down?
But not all agree with Littlewood, saying that getting rid of the tax-free cash lump sum could hurt those who have built up savings and damage confidence in pensions.
Tom Selby, senior analyst at AJ Bell, said: “Axing pensions tax-free cash just as automatic enrolment is fostering a fragile savings culture in the UK is a terrible idea.
“Being able to access a quarter of your pension pot tax-free from age 55 is one of the best understood benefits of saving in a pension, so ditching it altogether would have potentially disastrous long-term consequences.
“Rising average life expectancy, the increasing state pension age and the disappearance of guaranteed defined benefit provision is placing ever greater onus on individuals to provide for their own retirements.
“Given this context, public policy needs to be focused squarely on ensuring the environment encourages more pension saving, rather than pulling the rug from under people.”
Hurting the young
“There would also be severe practical issues if the government attempted to end tax-free cash for all,” Selby added.
“Those who had saved money on the assumption they would get 25% of their final fund tax-free would justifiably feel aggrieved at an essentially retrospective tax grab. Even introducing a cap on tax-free cash would create a severe cliff-edge, so it is likely complex transitional measures would be needed.
“Younger savers could also justifiably argue this would represent another kick in the teeth for their retirement ambitions as they would be less able to benefit from the tax-free cash incentive than their older counterparts.
“The floating of half-baked ideas such as this is exactly the reason the Government needs make a genuine attempt at bringing some certainty into pension tax policy.
“Savers need to feel confident that the pension tax rules won’t be changed every five minutes, which feels reasonable given we are asking them to lock their money away for decades.”
