Thousands of savers and older workers still saving for retirement have been given a last-minute reprieve from controversial plans on dividends and pension recycling that could have seen their tax bills rise.
The government has backed off cutting both the tax-free dividend allowance and the so-called money purchase annual allowance, which restricts the money that over-55s can put into a pension nest egg once they have accessed their pots.
The backtracking is likely to be welcomed by investors and older workers, but creates further confusion and uncertainty about whether it is only a matter of time before the plans are eventually introduced, or whether it signals a change in direction altogether.
Reprieve: Plans have been put on hold that would have restricted pension tax relief of over-55s who have already accessed their pensions
Other plans ditched for now include a ban on pension cold-calling and scrapping the increase to the £500 allowance that workers could receive towards financial advice paid for by their employers.
The plans were removed from the Finance Bill, which the government has pared right back in order to get it through ahead of the snap general election.
Yet this has delivered confusion for pension savers as the cut to £4,000 that has been removed from the bill had already effectively arrived on 6 April.
The proposed change, announced in November’s Autumn Statement and confirmed in the March Budget, meant that the money purchase annual allowance was to be slashed from £10,000 to just £4,000 a year from the start of the 2017 tax year.
This affects those who have already withdrawn funds from a defined contribution pension, also known as a money purchase scheme.
If more than this goes into their pension, from their contributions, employer contributions and automatic basic rate tax relief, they face punitive tax charges.
Crucially, however, the legislation covering the cut was part of the Finance Bill that was not due to go through until after the lower limit arrived on 6 April.
This means that at the moment, over-55s who have accessed their pension pots can continue to put away up to £10,000 a year and still benefit from tax relief.
The cut was designed to prevent people from recycling their retirement savings to gain a tax advantage – effectively taking tax-free cash from a pension pot and putting it back in again to get a second lot of tax relief.
WHAT IS A MONEY PURCHASE PENSION?
Pension freedoms only apply to people with ‘defined contribution’ or ‘money purchase’ pension schemes, which take contributions from both employer and employee and invest them to provide a pot of money at retirement.
They don’t apply to those with more generous gold-plated final salary or ‘defined benefit’ pensions which provide a guaranteed income after retirement.
However, those still saving into such schemes can transfer to DC schemes, provided they get financial advice if their pot is worth £30,000-plus.
Pension freedom reforms introduced in April 2015 have given over-55s greater power over how they spend, save or invest their retirement pots.
But once you start making withdrawals, limits are placed on how much extra money you can contribute to your pension pot and still automatically get tax relief.
The annual amount falls from £40,000 to £10,000 a year at present, and will be cut to £4,000 from next April, to prevent people recycling their savings to gain a tax advantage. Read more about pension recycling.
But industry experts at the time warned that it would curb pension freedoms, and worked against the very flexibility that they were designed to create.
Part of the criticism came from the fact that the government estimated that slashing the allowance by more than half would only pull in an extra £70million a year.
The outcry at the time was led by ex-Pensions Minister Steve Webb, who said it was unfair on older people who want to carry on working and saving.
‘Cutting this allowance flies in the face of efforts to make retirement more flexible,’ said Webb, who is now director of policy at pension firm Royal London.
‘As soon as someone draws a pound of taxable cash using the pension freedoms, the amount they can save in a money purchase pension would be slashed from £40,000 to £4,000.’
‘This will have a profound impact on their ability to go on working and contributing worthwhile amounts to a pension. Starting to draw taxable pension cash becomes even more of a cliff-edge than at present.
However, today he added that the situation we are left with now is ‘confused’.
He added that although the £10,000 allowance is still in place, financial advisers would be ‘unwise’ to advise clients to make use of it as there’s a danger that if the Conservatives are re-elected, they could not only still go ahead with the cut, but they could also apply it retrospectively.
Meanwhile his successor, former pensions minister Ros Altmann, questioned whether the move today could mark an end to the tax relief cut altogether.
She tweeted: Govt backing away from cut to MPAA may signal wider changes to pensions tax relief after election. Radical reforms possible?’
Jon Greer, pensions expert at Old Mutual Wealth, added that the hiatus is particularly confusing considering the policy has already been implemented since the beginning of this month and therefore people have already started to plan for the change.
‘While placing part of the finance bill on hold was inevitable with the announcement of the snap election, the government are reducing it to the bare bones in order to get it through.
“People will have already started planning for this change and a sensible approach would be to continue to do so as it may be backdated and still be applicable from April 6 this year.
“However, the cut to the MPAA is totally at odds with the direction of travel in the retirement market and those planning for retirement would be relieved if it became a casualty of the finance bill.’
Freezing: Chancellor Philip Hammond announced the dividend allowance cut, but it it now on hold
Dividend tax grab halted too
The cut to the tax-free dividend allowance was due to come into force in April next year, but has now been put on hold.
The £5,000 allowance that was launched to cushion the blow of higher tax rates on dividends and encourage shareholder investment was due to be slashed to £2,000, following an announcement in the Budget only last month.
The tax break means shareholders currently get to hold onto the first £5,000 of dividend income they earn each year tax-free.
On any dividend income they earn above that sum, basic rate taxpayers hand over 7.5 per cent in tax, higher rate taxpayers 32.5 per cent, and additional rate taxpayers 38.1 per cent.
The £5,000 tax-free allowance was ushered in by former Chancellor George Osborne when he hiked dividend tax rates in April 2016 as part of a crackdown on contractors avoiding income tax by paying themselves dividends.
Yet, less than a year later, the new Chancellor Philip Hammond hacked the allowance down to £2,000 and kept the higher dividend tax rates.
Half of the people who currently benefit most from the tax break are company directors with a shareholding in their business, who effectively get to take an extra £5,000 tax-free chunk of cash out of their firms each year, according to Hammond.
The other half are people who hold £50,000-plus of investments outside their Isa – inside an Isa wrapper dividends are tax-free.
While £50,000 may seem like a lot to have in investments, the move would have affected many older savers who had striven to accrue investments over their working lives and who now depend on the income from these to live on.
The changes would have forced increasing numbers to shovel as much of their investments into Isas as quickly as they could to protect their investments. They have been aided by a rise in the Isa allowance to £20,000 since 6 April.
If the Conservatives are re-elected, the dividend allowance cut could be back on the table, particularly as the Chancellor could argue once again that it would be a move most likely to affect wealthy investors – company directors and those with considerable investment pots.
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