The Government is to review the controversial tax treatment of trivial commutation pensions taken as cash that can see the poorest pensioners paying more than 30 per cent tax on their savings.
Although this tax is reclaimable, experts say much of it is unlikely to be reclaimed in the same way that many of the worst off pensioners do not claim pension tax credits.
This also threatens to undermine the Government’s Personal Accounts regime, which is set to be introduced in 2012.
The Department for Work and Pensions recently said that a key component of ensuring the Government can say it pays to save in Personal Accounts was ensuring that the poorest pensioners could take their trivial commutation pension – pension pots below £15,000 – with little or no tax paid.
The tax problem arises because the Government assumes that everyone is a higher-rate taxpayer and does not take into account individuals’ personal allowances, which hits the over-65s hard because many are lower or basic-rate taxpayers.
Hargreaves Lansdown head of pensions research Tom McPhail says: “The Government should charge basic-rate tax at the outset and square up later or get people to fill in a certificate outlining how much tax they are likely to pay in the year.”