Analysis recently published by the Office for Budget Responsibility reveals that one of Gordon Brown’s first decisions has cost workers £118 billion from their pensions
Why You Should Pay Attention When Tax Changes To Pensions Are Proposed (Like Now)
A Pensions Tax Change That Almost No-one Felt Has Had A Devastating Impact On Millions Of Us Holding Stockmarket Investments
Despite ignoring advice from his own officials about the dramatic consequences his pensions tax change could have, Gordon Brown went ahead and scrapped the tax relief on dividends paid into pension funds.
Before 1997, a pension fund collecting £80 in investment dividends after tax could receive an additional £20 credit from the Treasury. But thanks to Gordon, the credit was abolished, so pensions that invested in dividend bearing investments were no longer technically tax-free.
Since the change, the number of private sector workers with defined benefit pensions, or final salary pensions, has collapsed from 5 million to 1.7 million.
It’s been widely reported as a stealth tax, on the basis that people didn’t feel the pain of the pensions change. That is, until years later when they checked out how their pensions were doing. Many found the answer to be ‘not very well’. And a huge number were told ‘very, very badly’. In 1997, a third of all staff in private sector firms were in final salary pensions. 15 years later, just 1 in 12 were the lucky ones left. The rest, who have paid dearly for the pensions tax change, are reluctant recipients of a much less rosy retirement.
Is The 25% Tax Free Cash From Pensions Now At Risk?
As he closed his Budget in 2014, George Osborne announced some far-reaching pension changes that have subsequently thrown the pensions world into serious debate. Whilst they are broadly welcomed from all quarters, it seems he may now believe he’s gone too far, for in recent weeks, pension tax changes have been announced and there’s more to come in November. It feels like he’s using the interim period as a pensions consultation process, throwing out ideas to see how they’re received. The pensions world is currently all of a chatter.
Some eminent voices are suggesting the 25% tax-free cash is at risk, as the flexibility of pensions could open a £24 billion tax loophole. It’s implied the largest slice of tax will not find its way to the Treasury if instead of employees paying contributions to pensions personally, they have their employers make the pension payments on their behalf. Here’s an example.
How To Reduce Tax And National Insurance By 62%
A person earning £40,000 a year pays HMRC £14,267.35 in Income Tax, and employer and employee National Insurance Contributions. Instead, if the employee elects to receive the minimum wage for a 35 hour week, with the balance paid directly into a pension, HMRC receives just £5,484.48.
That’s a 62% saving for the employee, at the Treasury’s expense.
Some workers approaching retirement already make huge tax savings by sacrificing 100 per cent of salary, less minimum wage, into pensions, often for the last couple of years of employment. And from next year, providing they’re at least 55, they can draw out their entire pension fund whenever they want. The tax and national insurance savings can make this a worthwhile exercise.
If you have income from other sources, sacrificing your salary could be a good move, at least whilst it lasts. If you’re unsure of the benefits of such an action, it’s worth consulting your trusted tax adviser or your independent pensions adviser.
History shows that for millions of people, doing nothing isn’t really an option. It’s in your best interest keeping abreast of all changes to do with pensions, particularly during the ‘consultation’ process. And whenever possible, make your feelings known.
It’s Not All Pensions Doom And Gloom
Whilst stockmarket investments may no longer earn you tax-free dividends, pretty much every other form of investment inside pensions will generate tax-free returns. When it comes to SIPPs, that includes investing in commercial property, both in respect of any capital appreciation in the value of the property, and any rental income received. Loan interest is also received free of tax, whether it’s in the form of crowdfunding and peer-to-peer, or high interest bearing loan notes and corporate bonds.
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Over time, charges can wipe out a huge part of your fund. We like AJ Bell because there are no set-up costs. If you hold passive funds, which is our preference, or shares, investment trusts, EFTs, gilts or bonds, you pay one small fixed fee no matter how large your fund. And when you come to draw your benefits either as occasional drawdown or UFPLS payments, there's a small charge for the whole year no matter how many times you access your money (many SIPP and SSAS providers charge more than this for each payment). However, you should always compare charges in detail, because AJ Bell could be more expensive than other providers, depending on the type of stockmarket assets you hold.
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