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Are pension lump sums in tax peril?

Industry experts warn that any move by the Inland Revenue to phase out tax-free cash on pensions would destroy the population&#39s incentive to save and could be politically disastrous.

The reaction from IFAs and providers was sparked by comments from Retirement Income Reform Campaign director Oonagh McDonald at last week&#39s Pensions in Crisis Conference in London.

McDonald warned that the Revenue is looking at ways to phase out tax-free cash. The Revenue&#39s head of savings and pensions policy Paula Diggle and a Revenue team are working on a report on pension tax to generate ideas for a Green Paper expected in November.

McDonald told the conference: “It looks like the Green Paper on pensions will introduce a positive disincentive to save. My understanding is that Paula Diggle is cooking up ways of phasing out the cash-free lump sum. This will go down like a lead balloon. It may be seen as an anomaly but it is an issue that the Government needs to take a longer-term view on.”

A Revenue spokeswoman would only say: “We cannot comment because the review is ongoing.”

If McDonald&#39s warning comes to fruition, most of the industry thinks the effect would be detrimental. Most say they find it hard to see the logic behind such a move apart from one motive – the Government wanting to raise more tax to achieve its immediate aims.

IFA Bates Investment Services head of pensions James Jones-Tinsley says: “If the Government is looking at doing this, it is thinking in terms of votes, not the long-term effect on the country.”

Most commentators say they would be surprised if the Government scraps taxfree cash as it is one of the few remaining incentives for people to invest for retirement and help narrow the savings gap.

IFA needanadviser.com director Ashley Clarke says: “I have not heard about this but if the rumours are true, it will be the biggest blow to incentivising people to save for the long term since Robert Maxwell. The biggest barrier to encouraging people to save is that they do not have access to their money as it is tied up for retirement.”

IFAs say another consequence is that people with pension mortgages will not be able to pay off their loan if the tax-free lump sum goes.

The Bureaux director Ronnie Lymburn says: “There could be some element of truth in this rumour and it may come out in the pensions simplification document. But they would need to be careful how it is done. If it was introduced retrospectively, it would hit those who have earmarked the lump sum to pay off their mortgage.”

But Lymburn says a half-way house could let people still take the lump sum but without the tax relief.

As well as hurting the future of savings and pensions, providers believe that scrapping tax-free cash would be political suicide for the Government at a time when the pension timebomb is hitting the headlines on a regular basis.

Scottish Equitable pensions development director Stewart Ritchie says: “It would be extremely difficult in practice for the Government to chop tax-free cash. I do not see the House of Commons as turkeys voting for an early Christmas.”

But, while dismissing the idea as unworkable, some commentators admit that it could be feasible as part of an overall review of tax and if other incentives or compulsion were introduced in its place.

Ritchie says: “Tax-free cash is a clear incentive to save for retirement. I do not see how it could be phased out unless the Government does introduce compulsion or some alternative form of incentive.”

He says the ABI is examining the possibility of offering incentives to employers to provide a good pension scheme for employees by “doing something nice” to National Insurance contributions. Ritchie says: “This would fall short of compulsion but could be quite an attractive carrot and stick.”

Clerical Medical pensions strategy manager Nigel Stammers says the only way that the lump sum could be taxed is as part of an overall tax review introducing some type of quid pro quo. He says one approach could be to introduce full concurrency so no one has to make the choice between an occupational, stakeholder and personal pension rather than the present situation where only those earning under £30,000 are exempt from this decision.

Stammers says: “The industry has asked for full concurrency but this would be costly. Removing the tax-free sum could bring the coffers into the black.”

Standard Life senior technical manager John Lawson says although he does not see scrapping tax-free cash as politically acceptable, he points to Sandler&#39s opinion that tax incentives do not encourage savings. He believes one option is Pickering&#39s suggestion that people should be able to take tax-free cash from the contracted-out part of their pension, something that is not allowed in the current structure.

Although the overwhelming view is that phasing out tax-free cash would be politically and economically treacherous, the industry is not completely discounting McDonald&#39s warning.

Clarke says: “This rumour could be scaremongering or the Government has no idea about how the public perceive savings.”

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