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IFAs hit back after think-tank suggests tax-free pension cash cap

Capping the tax-free lump sum for pensions at £40,000 would raise an additional £2 billion a year for the government, the Resolution Foundation has said.

IFAs hit back after think-tank suggests tax-free pension cash cap

Advisers have voiced strong concerns over the Resolution Foundation’s suggestion of capping tax-free lump sums for pensions at £40,000.

A report by the influential think-tank Resolution Foundation published yesterday suggested limiting the tax-free lump sum to £40,000 to raise more tax revenue from wealthier segments of the population. The report said this change could raise an extra £2 billion annually for the government.

‘The current ability to take over £250,000 tax free is worth up to £119,000 to an additional rate taxpayer, £105,000 to a higher rate payer, £53,000 to a basic rate payer and nothing to lower income pensioners who’d be below the personal allowance each year anyway,’ the report’s authors Resolution Foundation director Torsten Bell and senior economic analyst Adam Corlett said.

Currently pension savers are usually able to take up to 25% of the amount built up in any pension as a tax-free lump sum. With the lifetime allowance at £1 million, the maximum tax-free lump sum that can be taken is £250,000, unless the member has been granted protection by HM Revenue & Customs.

The think tank said capping lump sums at £40,000 would leave three-quarters of future pensioners unaffected. This cap was also called for by the Liberal Democrats at its conference last year.

However, a number of advisers and industry commentators have sighted issues with this proposal.

Penney, Ruddy and Winter director David Penney said capping tax-free cash at £40,000 retrospectively would ‘undermine the pension system’ and discourage younger people from saving into a pension.

Henwood Court Financial Planning managing director Nick Platt said: ‘A further reduction to tax-free cash would create a massive disincentive for people to save into pensions and reduce their appeal. Such an act would be a backward step and one that should be avoided.’

Platt said pension tax relief has already been significantly reduced over recent years with cuts to the lifetime and annual allowances.

Curtis Banks pension technical manager Jess List said the change would have a huge psychological effect on pension savers.  

‘Tax free cash is a huge incentive for pension saving and such a drastic reduction could send the wrong message at a time when the government is trying to encourage people to save more for retirement.

‘The paper also overlooks how complex a change this could be in practice: the tax free cash limit is currently tied to the lifetime allowance, and changing it to a fixed figure would represent a significant legislative change,’ she added.

Limiting IHT

The Resolution Foundation’s report also proposed keeping inheritance tax (IHT) tax-free thresholds at £1 million, rather than see the limit further increased with inflation, a move which could raise £200 million a year by 2022-23.

By 2020-21, couples will be able to pass £1 million onto their children tax-free as the government is increasing the residence nil-rate band for individuals to £175,000 by this point. This is in addition to the current £325,000 IHT threshold.

Platt said: ‘Capping IHT relief at £1 million would be grossly unfair because in the future the real rate of tax would increase, which would expose a larger proportion of an estate to IHT, continued inflationary increases to the nil rate bands is therefore totally fair and justifiable.’

The think-tank report said the current IHT system coupled with pension freedoms has the ‘ludicrous effect’ of encouraging pensioners away from spending their pension money so they can pass it onto their children when they die.

The Resolution Foundation report said the removal of the lifetime ISA and Help to Buy ISA and tweaking council tax, along with the other reforms, could provide the Chancellor with an addition £7 billion a year by 2022-23.

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