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Under the influence

The previously overriding tax attractions of pensions are likely to be diminished by restriction of higher-rate relief

Question: Would you rather have £1m in your pension fund or £1m?

Answer: The latter.

Question: Would you rather have £1m in your pension fund or £800,000?

Answer: Hmmm…

Question: Would you rather have £1m in your pension fund or £700,000?

Answer: Hmmm…

OK, not the most elegant or articulate start to a (supposedly) technicallyoriented article but these hypothetical questions are quite interesting aren’t they? The answers are only what I think a significant number of UK investors would give.

I feel pretty convinced about the first. Save for those who really do not trust themselves with money, I believe that most would choose to have the proposed £1m accessible and free of the constraints that a registered pension arrangement imposes on those who benefit from the tax relief given to encourage investment in the said pension fund.

It gets interesting when you put noticeably lower sums up against a pension fund.

Now I do not profess to know what any individual would choose but I do know that the benefits you can take from a registered pension arrangement would be in the form of 25 per cent tax-free cash and the rest to provide a taxable income.

If 75 per cent of the fund will then suffer a tax rate of 50 per cent (the new “additional rate” for those with taxable income over £150,000), the effective rate on the whole fund would be 37.5 per cent.

If the member’s tax rate during benefit withdrawal was 40 per cent, then the overall effective rate would be 30 per cent.

But to stay true to the line of debate I started, we ought to concentrate on the relative attraction to individuals of the form of benefits that can be taken from a pension fund or from some other “unconstrained” environment.

The limitation of tax relief through the special annual allowance charge or (in the future) the high-income excess relief charge will definitely cut down (potentially significantly) the financial difference between the value of a pension fund and a non-pension investment

And this is to focus on the value to individuals of an all-accessible flexible benefit “pot”. That is not what you get with a registered pension scheme.

It is because of this that I put forward the “hmmm” answers to the second two hypothetical questions.

I believe that there are more than a few who would select a tangibly lower sum outside of a pension than a tangibly bigger sum in a pension.

ow much lower, I don’t know. Obviously, the nearer the unconstrained sum is to the pension pot value, the easier it will be to choose it. But such is the pull of accessible cash, it may be that many would be prepared to accept quite a bit less.

I am encouraged to have this view by the quite strong interest that has been shown in the various ways put forward (some legitimate and some not so) for unlocking pensions.

Qrops is an obvious example. How many individuals (especially business owners) do you know who have said: “If only I could get my hands on some of the money locked up in my pension fund?

Now, in some circumstances (in a patronising “it’s for your own good” like way), it may be just as well that funds are not accessible and the member will, in the long run, be well served by the inaccessibility.

Subject to this, though, if there is a strong sentiment (when it comes to taking benefit) of regret and frustration at the funds being locked into a pension, then it is entirely valid to ask the question: “Why did you invest into a pension in the first place?”

Well, in my view, many who have invested in a pension for long-term financial planning (especially higher-rate taxpayers) will have done so because of the outstanding tax benefit on input and, on accumulation, tax-free gains and income and, even to some extent, on benefit withdrawal in the shape of tax-free cash. These excellent, unbeatable tax benefits will have caused many to not even consider alternatives.

These investors will also not have considered carefully enough whether the form in which they would be required to take benefits would be one which they would find acceptable.

The power of tax advantage has never been so successfully shown than with registered pensions. It really has influenced and continues to influence investor behaviour. Those who are entirely happy with the form of the benefits secured by the pension will have done an excellent job.

The tax attractions largely remain but for those who, when prompted to think about it, would say: “Yes, I would prefer unconstrained benefits” and especially where they would be detrimentally affected by the restriction of higher-rate tax relief on the pension input, then a consideration of pension alternatives could be well worthwhile.

The limitation of tax relief through the special annual allowance charge or (in the future) the high-income excess relief charge will definitely cut down (potentially significantly) the financial difference between the value of a pension fund and a non-pension investment.

The amount would depend on the facts of each case but for high-earning, non-pension lovers this will be a very interesting development and one worth spending a little time on with an informed adviser to model some potential outcomes before making a decision on how to invest.

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