Ability to withdraw cash could backfire on both savers and providers, writes Jeff Salway
REPACKAGED government plans encouraging people to treat their pension pots like bank accounts have been dismissed as a political manoeuvre that could backfire on both savers and providers.
It was confirmed in the Taxation of Pensions Bill last week that members of defined contribution (DC) schemes will from next April be allowed to take cash from their pension in small lump sums and get the first 25 per cent of each slice tax-free.
The proposal, included in draft legislation published during the summer, was just the latest component of the pensions shake-up to be set out by the government.
The ball was set rolling in the Budget, when Chancellor George Osborne revealed that from April 2015 savers aged 55 and over will be able to take their entire pension pot as a cash lump sum, including 25 per cent tax-free. The remainder will be taxed at the individual’s marginal rate, rather than the current 55 per cent charge.
The additional details outlined last week are in one sense nothing new, as it’s already possible to take pension cash in segments through phased drawdown. Previously drawdown had restrictions limiting its use to a small minority of affluent pension savers. Those restrictions were eased earlier this year as part of the changes set out in the Budget, although the pension pot must still be split into tranches before phased drawdown begins.
The rules published last week mean that far more people will be able to take their tax-free cash in small lump sums.
But the significance of the latest announcement isn’t in the content, according to Rachel Vahey, an Edinburgh-based independent pensions consultant, but in the way it was presented.
Until now the ability to take a series of small lump sums was set out by HMRC in the new Uncrystallised Funds Pension Lump Sum (UFPLS) rule. It had two functions, she explained.
“First, to allow a form of phased retirement. And second, to help those schemes who didn’t want to go to the trouble of introducing drawdown to provide a way of allowing their scheme members access to their funds on retirement.”
However, the government has given the concept a new mass appeal by repackaging it as a “pensions bank account”.
“Can any provider or scheme live up to the promise that the phrase ‘pension bank account’ evokes? Will people be able to get hold of their retirement fund from a cash machine? I doubt it,” said Vahey.
The plans create a fresh problem for pension firms, she added.
“They were busy drawing up plans to offer drawdown to scheme members from April. Only those who couldn’t be bothered with that would have even considered UFPLS. But now, all schemes will be forced to at least think about whether to offer it, otherwise they risk denying members their ‘freedom’,” said Vahey.
The upshot is that many pension providers will be unable to put UFPLS processes in place by next April, while those who do offer it may impose hefty charges.
Savers will need to think “very carefully as to whether this is the right option for them”, said Kate Smith, regulatory strategy manager at Aegon.
“This isn’t the same as accessing a bank account, it’s a long-term savings plan, invested in a range of investments,” she said. “As soon as people start to withdraw sums above the 25 per cent tax-free cash it potentially starts to limit future pension savings, as the amount they can put into a pension each year and receive tax relief on, reduces from £40,000 to £10,000.”
Payments made as UFPLS are unregulated, she pointed out. “This new income option is potentially open to abuse by unscrupulous organisations encouraging people to take their money out of a preferential tax environment and promising to invest cash on savers behalf.”
Tom McPhail, head of pensions research at Hargreaves Lansdown, accused the chancellor of “creating the perfect environment for a mis-selling scandal”. “Without regulatory oversight, when investors do run out of money – and some will – there’ll be no accountability for this system failure,” he said.