Remember when Liz Truss’s government announced the abolition of the UK’s top rate of income tax (a nasty 45%) and the nation’s high earners practically danced in the streets? They are at it again.
On Wednesday, Jeremy Hunt announced some changes to the pension system that should make all high earners very happy indeed. The annual allowance has been raised to £60,000 ($72,366) from £40,000, and there is to be no limit on how much they can have in that pension at all. The Life Time Allowance (LTA) that was set at £1,073,000 is gone.
There are a few things that make this less brilliant than it sounds. You can only put as much as you earn every year into a pension — if you don’t earn £60,000, you can’t put £60,000 in. And if you earn over £260,000, your annual allowance gradually tapers away to £10,000 (up from £4,000). The amount you can take tax-free when you retire has also been frozen — it was 25% of your pot, now it is to be £268,275, something that changes the sums a little.
Still, there is good reason for the well-heeled to be dancing.
Put £60,000 a year into a pension wrapper, and you could have a good £3.5 million by the end of the whole thing, says financial advice firm AJ Bell. If you are so well off that you don’t have an allowance of your own or you use it up all too early, you can stuff the pensions of your lower-earning spouse and kids instead. Stuffing your spouse’s is a good idea — if he or she dies before they are 75, the kids get the lot tax-free; if you hang on longer, they still get it free of inheritance tax (although they have to pay their own marginal rate of income tax on withdrawals). Stuffing your kids’ is a good idea too: You earn, they get the tax back, and the cash gets to roll up tax-free in a wrapper owned by one member of the family.
It is also lovely for senior members of the civil service and the NHS. The generosity of the public sector defined-benefit system has meant that many have hit the LTA — and let the rest of us know they don’t fancy paying tax on the excess (as they old system insisted) very loudly indeed. Perhaps they will now complain less and work longer. Or perhaps not.
The thing is that the LTA was never as much of a problem as some thought. The penalties on the LTA excess did not have to be paid until the pension was drawn, and it arguably left most people roughly in the same tax position as if they had simply paid the tax upfront. You could also say with some logic that the LTA was quite high enough — possibly too high, in the first place. If the aim of tax relief on pensions is to persuade everyone to save just enough to create an income that will prevent them from being a burden on the state in their old age, it surely needs to be more like £600,000 than infinite (you need around £20,000 a year to not be a bother to the state).
The annual allowance, however, is as much of a problem as the complainers say. It is insanely complicated, full of things to be confused about and punitive in a way I suspect its architects did not anticipate. High-earners in the public sector hate it. Hit the limit and they have to leave their (generous) schemes, pay tax bills upfront from current incomes not always high enough to carry them out easily, cut their hours or shifts, or get their schemes to pay and subtract the bill from their pension pot later (and that comes with interest).
But it is even worse for the private sector, which has no scheme to cover the tax liabilities in the short term. The annual allowance fails to take into account the extent to which earnings fluctuate. MPs and civil servants may have incomes that stay reasonably constant (inflation-adjusting aside) regardless of age, economic growth and experience. The rest of us just don’t.
Those earning enough to hit the annual allowance and, crucially, the hideous taper will mostly be able to count the years we do so on one hand. These should be the years we build up pension savings. They are also the years when we cannot. The annual allowance is complicated, unfair, and insanely stressful for anyone who even begins to understand it. It is everything a tax should not be. Jeremy Hunt abolished the wrong thing.
More From Bloomberg Opinion:
• Jeremy Hunt’s UK Budget Is a Minimalist Master Class: Marcus Ashworth
• Should the Government Get to Spend Your Pension Savings?: Merryn Somerset Webb
• Britain’s Beloved John Lewis Has Fallen From Grace: Andrea Felsted
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Merryn Somerset Webb is a senior columnist for Bloomberg Opinion, covering personal finance and investment, and host of the Merryn Talks Money podcast. Previously, she was editor-in-chief of MoneyWeek and a contributing editor at the Financial Times.