Finance June 2014

Why the government needs your pension

London reforms mean more tax liability

  • New lifetime allowance not linked to indices or growth
  • Already 509 tax hikes since 2010
  • Changes in legislation affect anyone with a UK scheme

The recent UK budget has been described by the Institute of Directors as “the most radical reform to pensions in decades”. Given the UK’s fast-increasing national debt (a massive £108bn this fiscal year), Chancellor of the Exchequer George Osborne has become creative with our pensions.

Not only has the annual contribution been reduced to £40,000 per year, but the maximum lifetime allowance (LTA) has been capped at £1.25mn. The latter figure is significant, in that it is not index-linked nor does it account for any growth. Thus, should your pension exceed this amount, there is a potential tax liability of 55% on the excess.

So why does the government need our money in the first place?

Statistics from the Office for Budgetary Responsibility suggest that government spending in 2013 amounted to £700bn, or 45% of GDP. Tax receipts, however, amounted to only £557bn. With a welfare budget of some £200bn and a planned £12bn in spending cuts this year, the UK needs to find a staggering £120bn to balance the books.

State pensions of £83bn account for almost half the social security budget, while public sector schemes require a further £36bn. Given the trend towards longer life expectancy, these contributions are simply not enough; the deficit is forecast to increase £2bn a year.

A document published earlier this year states that the infamous raid on pensions by the Labour Party government in 1997 now costs taxpayers an enormous £10bn a year. Not only that, but the £118bn that was raised thereafter was frittered away during the boom and bust period of the past 10 years.

So, unless the government overhauls its entire spending programme, taxes will continue to be increased (509 tax hikes since 2010) in ever more innovative and creative ways. That is why pensions are such a healthy target for our political masters.

What this means for you
In a lifetime, people’s two biggest expenses are likely to be a home and a pension. Assuming you have a UK scheme, you must be aware that, because this is a UK asset, it is likely to be taxed as such, irrespective of where you reside.

In addition, as the value of money generally halves every 12 years, the maximum threshold for the LTA could be achieved by even the most modest amount today. This assumes a 7% average return on the scheme per year (the FTSE All-Share Index has returned an average of 6.87% per year over the past 52 years).

So, here’s the message: assuming the above figures, a 30-year-old person hoping to retire at age 66 would be hit by the 55% death tax under current legislation if his pension today were worth £107,000.

Incredibly, that person would surpass the maximum LTA level by the age of 62 if he were to invest a mere £47 per week! It is evident this is not just a rich man’s tax, but a tax on all wealth.

It is a clear and well-known fact that the state of UK finances is parlous. Government spending at current levels is unsustainable and is only maintained by ultra-low interest rates.

It is also clear that many people have no interest in, nor the knowledge to understand, what exactly is being done to the UK pension system and, more important, what it means for their future.

If you have a UK pension, however trivial you may view this issue, action should be taken at the earliest opportunity. Remember, it is better to have too much rather than too little money in retirement.

Don’t underestimate the amount of money you will need nor the likely fact you will live into a healthy old age. It is vital you be aware of changes in legislation that affect how you plan your future replacement income.

Finally, there are more tax-efficient and less restrictive ways of planning for your retirement in addition to any UK pension. These options should be explored to establish whether you are on track to meet your goals, and whether you are invested through the very best company structure to fulfil your needs.

Carpe diem.