by Samuel Dale
Buried deep in this year’s dull Budget was a secret £6.5bn tax raid on pensioners and savers under the guise of radical reforms.
George Osborne’s most significant policy announcement was the proposal to allow pensioners already drawing an annuity to sell their policy in exchange for a lump sum.
It is the second stage in major pensions reform announced in last year’s Budget to allow all over-55s to access their pension pots.
The first stage of pension freedoms is relatively simple. The pension system saw savers build up a retirement pot of cash with generous tax relief on contributions. In exchange they had to buy a secure income or annuity (or face a punitive 55% tax if they withdrew their cash from the pension wrapper).
Annuities work as a reverse insurance product so you pay over a big chuck of cash to the insurer and in return they pay you money every month until you die. Insurers pool the risk so those who die earlier fund the payments for those who live longer than expected lives.
As people live longer insurers are paying a lower amount each month over a longer period, making pensioners buying them poorer. Successive Governments have taken steps to ease the requirement to buy an annuity by allowing wealthier investors to drawdown their own money.
But Osborne’s announcement last year, coming into force on 6 April, is the big bang. It means anyone can withdraw their pension pot at marginal income tax rates (although everyone receives an initial tax-free lump sum of 25%).
The Treasury estimates the behavioural changes will see individuals wanting the money today despite the tax penalties. It will lead to many savers paying income tax on withdrawals they have never paid before.
So how much does it cost?
The 2015 Budget documents show first stage of freedoms will raise £310m more tax in 2015/16 then £585m in 2016/17, £890m in 2017/18, £1.2bn in 2018/19 and £785m in 2019/20.
It is worth pointing out that the OBR puts these estimates as highly uncertain based on the unknown behavioural impact of the reforms. But, caveats aside, this measure raises almost £3.8bn over the parliament and it will go on raising money every year until 2030.
The second stage of the revolution is the creation of a second-hand annuity market.
The idea, pushed by Lib Dem pensions minister Steve Webb, would allow those who have already bought a lifetime annuity the chance to access freedoms as well.
The Treasury is consulting with the aim of launching in April 2016 to allow people already receiving income from an annuity to sell that income to a third party subject to agreement from their annuity provider.
The proceeds of the sale could then be taken directly or drawn down over a number of years, and would be taxed at their marginal rate, in the same way as those taking their pension after April 2015.
Sounds straightforward but it is a fiendishly complicated idea fraught with difficulties, riddled with contradictions, complications and on a very tight timetable.
Labour are cautiously supportive but Ed Miliband warned about getting the regulations right to stop “rip-off” pension scams preying on the old.
Again, the change would create behavioural shifts as more people want the cash now even if there is a tax hit.
So how much does it cost?
It would launch next year and raise £535m in extra tax for 2016/17 followed by £540m in 2017/18 before costing the public purse £130m in 2018/19 and £120m in 2019/20.
From April 2015 to 2020 the combined impact of both stages of pension reforms is estimated to raise £4.6bn in extra tax. That is money coming directly from the saving pots of pensioners over the course of the next parliament and we haven’t heard a peep from Labour.
Then there is the latest Budget cut to lifetime allowance for tax relief on pension contributions from £1.25m to £1m. This collects another £1.9bn in tax over the parliament.
On the flip side, pensioners could benefit from new measures to make ISA withdrawals more flexible and a new £1,000 tax-free allowance on the interest payments of cash savings for basic rate taxpayers.
They will also benefit from very generous pensioner bonds paying market-busting rates of 2.8% interest over one year and 4% over three years, exclusively for the over-65s.
But the key pension reforms on extra flexibility and a new annuity market amounts to a well-disguised £4.6bn tax raid on pensioners in the next five years. If you include the new cuts to pension tax relief then this week’s Budget revealed £6.5bn in extra taxes raised from pension savers if the Tories are elected.
Osborne has done everything to attract pensioners back to the Tories and polling suggests his flexibility reforms are popular. Only he could dress up a £6.5bn tax rise as positive Budget for pensioners and Labour is letting him do it.
Sam Dale is a financial and political journalist