Fairness is in the Eye of the Beholder?

 

BLOG 219

 

FAIRNESS IS IN THE EYE OF THE BEHOLDER?

 

I noticed a recent article in International Investment headed “two-fifths of over 55s “unfairly” on £4,000 pension contribution danger line”.  This tells me that “two-fifths of working over-55-year-old prospective retirees are unaware of Money Purchase Annual Allowance (MPAA) restrictions despite many flexibly accessing their pensions in past 12 months according to new research by Canada Life, which is calling for the MPAA to be scrapped”.

 

The £4,000 limit arises from the pension flexibility introduced in 2014 by George Osborne.  This allowed people to access their entire pension fund flexibly from age 55.  It was soon discovered that wicked people were drawing money tax-free from their pension pots and reinvesting the money in new pension contributions, so doubling up on the income tax relief.  Accordingly, the cap for such reinvestment was introduced in 2016 initially at £10,000 but reduced to £4,000 in 2017. 

 

Whether it is unfair to seek to counter tax avoidance in this way depends of course on one’s perception of fairness.  The UK gives full income tax relief for pension contributions up to the amount of the annual allowance, which is currently £40,000.  The MPAA only applies once a person has started to access their pension fund.  The purpose of tax relief is obviously to encourage people to set aside money during their working life to provide for their retirement.  The bargain is that the government will grant tax relief for the contribution and will enable 25% of the resultant pension pot to be withdrawn tax-free with the remaining funds being used to purchase a pension which will be taxed on receipt (in most cases at a lower tax rate than the rate on which relief was given). 

 

It is questionable whether it is fair to grant relief for savings which are invested to provide a pension, but not to grant tax relief for mortgage payments which are invested to provide a home on retirement and thus reduce the need for pension income to pay rent.  Be that as it may, the Canada Life report does not itself talk of unfairness.  It tells us that 14% of working adults over 55 have flexibly accessed their pensions and two-fifths of all respondents are unaware of restrictions, such as the MPAA.  Two-fifths of 14% is 5.6%.  This suggests that out of the 1,013 respondents to the survey, 141 have flexibly accessed their pension and 57 of these were not aware that by doing so they had capped future pension contributions at £4,000 p.a.  I do not find that particularly worrying, but do have a concern that those 57 people must have been told about the MPAA by their pension provider when they decided to access their pension but did not understand what they were being told.

 

Apparently, of those who accessed their pension pot in the last year, 42% (425 people) did so to top up their income, 25% (253 people) used the money to make home improvements and 17% (172 people) put the money into non-pension fund investments.

 

55% of the people who accessed their pensions have also continued to make new tax-deductible contributions to their pension scheme. 

 

Personally, it does not seem to me particularly unfair to limit the future tax-deductible pension contributions that can be made by people who use the money set aside for pensions to make home improvements or to invest outside the pension wrapper.

 

I have sympathy with those who had to draw money from their pension fund to supplement Covid-hit income.  However, I suspect that most of those are fairly lowly paid and as such are not unduly affected by a £4,000 contribution limit.

 

Canada Life have produced a table which shows that for an occupational pension scheme, the £4,000 MPAA will only cover the 8% auto-enrolment minimum contribution if the salary does not exceed £50,000.   Canada Life tell me that “retirement journeys are changing, and it is no longer the cliff-edge event it used to be.  Many more people are choosing to retire later for a variety of reasons and continue working in older age, either by reducing their hours, setting up their own business or perhaps embarking on a less pressured career”.  It is by no means clear why this should mean that those who decide to set up their own business or embark on a less pressured career should expect to withdraw funds prematurely from their pension pot and to be given tax relief to then refill that pot.

 

I can understand that those who reduce their hours are likely to reduce their earnings in consequence and to need some recourse to their pension fund to maintain their standard of living.  However, I would expect the company’s contributions to be reduced accordingly.  On that basis, on Canada Life’s figures, a person earning £50,000 who reduces his hours to a 3-day week would be earning £30,000, and £4,000 allows a 13% pension contribution at that level.  A person earning £50,000 for a 3-day week is equivalent to earning £83,333 for a 5-day week.

 

The HMRC PAYE statistics tell me that a person earning over £55,500 per annum is in the top 10% of earners and a person earning over £75,800 per annum is in the top 5% of earners.  Accordingly, most employees are not affected by the MPAA; it is only the top earners who are affected.  Canada Life comment that the MPAA “is quite simply penalising people for doing the right thing”. I find it hard to regard taking money out of that set aside for pensions to make home improvements or to invest on the stock exchange as “doing the right thing”.  I equally find it hard to agree with Canada Life that it is “deeply unfair” to limit the ability of those who look to their pension pot to manage their expenses or cover unexpected costs to be limited to tax relief on £4,000 per annum of new pension contributions made to refill their pension pot.

 

I know that the MPAA is hated by the financial services industry.  I do not particularly like it myself as it is a nuisance and an extra complication to the tax system.  However, “unfairness” is the last thing I would accuse it of.

 

 

ROBERT MAAS