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Budget tax rules create small pots loophole

Experts say measures to stop people exploiting tax relief on pension contributions run counter to the Government’s effort to solve the problem of small pension pots.

The new tax rules, announced following this year’s Budget reforms, contain changes to the annual allowance for pension contributions. To stop people recycling tax relief, from April once a member accesses their pension through flexi-access drawdown or takes an uncrystallised funds pension lump sum, their annual allowance will drop from £40,000 to £10,000.

But cashing out a lump sum worth less than £10,000 – the auto-transfer pot limit proposed by the Department for Work & Pensions – will not trigger the reduction in the annual allowance. Individuals can take small lumps from an unlimited number of occupational defined contribution schemes and a maximum of three personal pension schemes.

Allen & Overy senior professional support lawyer Helen Powell says: “The ‘freedom and choice’ tax changes work in the opposite direction, incentivising workers to opt out of the transfer system.”

AJ Bell technical resources manager Gareth James agrees, as the rules stand, the system can be exploited but says the numbers who could benefit are likely to be “very small”. 

“To appreciate the opportunity requires a detailed understanding of the regulations and the number likely to have the detailed understanding of the rules to this degree or have an adviser who advises them to create lots of small pots is likely to be negligible,” he says.

“When you consider the difficulties associated with running lots of different pensions rather than merging, and the costs of all parts of the exercise, we don’t think large numbers would go to the trouble.”

Annuity Exchange director Stuart Bayliss adds: “HMRC will have done the downside assessment and not deemed it worth sorting out now.

“If they’ve found that each person gaming the system costs £250 a time, they’ll leave it for next time. They can’t do everything in the time they have from now until April.”


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There are 4 comments at the moment, we would love to hear your opinion too.

  1. Guys, why don’t you spend time on real, practical solutions for most of the clients, most of the time who will want flexible access reasonable amounts of pension lump sums at various points on the life-planning journey?

  2. Claire Trott - Talbot & Muir 12th September 2014 at 10:15 am

    I have to agree with Gareth here that the numbers involved would be very small. Those who could take advantage are unlikely to be taking financial advice so would not really be aware of the loophole.

    Those taking advice are unlikely to be advised to do it in the first place.

  3. Individuals wishing to abuse this would be limited to 3 bites at the cherry (at £250 a time). To use the occupational route would require scheme/employer complicity, which for the average employee is not going to be forthcoming. It is at most an anomaly. To sensationalise it as a “loophole” is symptomatic of the culture that ultimately leads to the need for complex regulation. (PS: the annual allowance does not reduce to £10k. In over-simplified terms, it becomes split between £10k for money purchase AA and balance, up to £40k, “other” AA. That’s why it’s called “money purchase annual allowance”.)

  4. P.S. Not sure why I repeated the £250 figure. Someone maxing out at £10k would benefit to the tune of £500 (£2,000 relief on the way in, £1,500 tax on the way out).

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