As we move into the final week before the Budget, I have found myself going down a Pension Rabbit Hole.
The latest rumours are now that the Budget will bring changes to the amount of tax free lump sum allowed from pensions but, and it is a massive BUT, with a carve out or exemption for members of public sector pension schemes.
Now this is something which I have covered in a number of previous blogs; both the difficulty in making changes to tax relief or tax free lump sums without a major impact on public sector pension schemes, and the possibility of an exemption for such schemes, with the resulting political fallout that would come from that. However, the rumours continue to persist that there will be action and that there will be an exemption or special arrangement for public sector schemes.
One of the rumours is that employer National Insurance will be added to employer pension contributions, in tandem removing the benefit of salary sacrifice (giving up salary in favour of an employer pension contribution). Here an exemption for public sector schemes would make sense, since the employer is the State, there would be little to be gained in the State giving with the left hand and taking back with the right.
The rumours about changing the way tax relief works seem to have subsided somewhat, which is no surprise to be honest. The potential complexities alongside the potential resistance would put this firmly on the “there must be an easier way” pile. The one that now seems to be making the running is the reduction in the tax free lump sum one, and that’s one where without a[ public sector scheme exemption we would be facing down an avalanche of strikes from teachers, doctors, civil servants and others.
As I’ve pointed out before though, when there have been reductions in the past 18 years in the maximum pension fund or lump sum, there has also been the ability to apply for Protection of the current maximum.
The principle that legislation should not be retrospective means that we have at least eight forms of Protection of Lifetime Allowances and the ability to take 25% of that Protected amount as a tax free lump sum. This principle was reinforced in the recent introduction of the Lump Sum Allowance, by legislation making it clear that this did not restrict someone who had an earlier Protection from drawing 25% of their Protected Lifetime Allowance pension fund value.
Then it hit me, maybe, just maybe this is a Blackadder style cunning plan?
If the Lump Sum Allowance were reduced to £100,000 say, but the ability to elect for Protection at the current £268,275 were offered, it could kill two birds with one stone.
Previous versions of Fixed Protection allowed you to retain the Allowance level, whether you had reached it or not, but on the basis that you were not allowed to make any further contributions to any pensions.
ONS figures for 2020 showed the “average” pension funds per household at only c£117,000. Even allowing for how misleading averages can be (mean or median anyone?) the implication is that most are a way off the £400,000 which would be needed to max out the lump sum at £100,000.
However, higher or additional rate taxpayers are far more likely to have larger pots and to have funds in excess of £400,000 already. So if you make the cut to the Lump Sum Allowance as drastic as cutting to £100,000, the chances are that large numbers of higher and additional rate taxpayers will cease contributions, if they are still contributing now.
At a stroke you reduce the amount of tax relief going out without having to worry about the complexities of trying to introduce a flat rate 30% relief for example.
Now you still have the issue of the public sector schemes. Here however a solution can be found by exempting them but only for any specific lump sum entitlement already built up.
The old public sector schemes generally built up an entitlement to lump sum alongside the entitlement to income each year that you were a member. So if the income built up were £100pa then the lump sum would be £300 at retirement. Difficult to restrict this when it is a specific and clear entitlement in the rules of the scheme.
However, the new schemes are different, and of course all public sector employees have now been moved into the new schemes. Current schemes work on the basis of building up an entitlement to income each year with the right to convert some of it to a tax free lump sum on retirement, subject to whatever maximum allowances or restrictions may be in force at the time you retire.
Due to the McCloud Remedy extending old scheme membership to 2022, any benefits built up in the new scheme are, for most people, likely to be too small for a lump sum change to really matter. Those who joined such schemes more recently and never had any old scheme benefits will always have had an income based scheme with the right to convert some of it to tax free cash and the point at which this happens is retirement, not when you are clawing your way up the greasy pole of power in the Home Office.
So there you have it, exempt the old scheme from any change to the Lump Sum Allowance, including the built in inflation increases to old scheme benefits, and leave the new scheme subject to the reduced maximum. There will be objections and dissatisfaction but being able to protect what you already have is a powerful psychological tool and an exemption for the public sector that is simply whatever you are entitled to already should be a far easier sell to the general public.
I could be overthinking this; I could be buying in to baseless rumours; I could be giving the Government far too much credit for knowing what they are doing.
