Pension freedoms turn into tax bonanza

HMRC form with money

The Treasury has admitted the pension freedoms announced in the March 2015 Budget and implemented in April 2015 have raised five times more tax than anticipated.

The new pension rules allow individuals to withdraw money from their pensions as they wish after age 55. However, only the first 25 per cent is paid tax free; you need to pay tax on the remaining 75 per cent.

This money is taxed at your marginal rate (the highest rate of tax that you pay) and, depending on your income for that year, it may push you into a higher bracket.

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The pension freedoms were initially estimated to raise around £300 million in 2015-16 and £600 million in 2016-17, although the estimates were subject to considerable uncertainty.

In the event, the measure has raised far more than anticipated - £1.5 billion in 2015-16, while the latest estimate for 2016-17 is £1.1 billion.

The original costing assumed individuals would spread their withdrawals over four years, but the latest HMRC information points to larger average withdrawals than were expected.

Some individuals are taking larger amounts than they would have been able to purchase through an annuity, thereby creating a higher tax liability.

Andrew Tully, pensions technical director at Retirement Advantage, says: 'This is a tax bonanza for the Treasury and although a welcome boost to government coffers, will have been a nasty surprise for many people taking advantage of the new freedoms.

'Paying tax on withdrawals was seen at the time as a natural brake on withdrawing too much too soon but this clearly hasn't been the case.'

Stephen Lowe, group communications director at specialist financial services company Just, says: 'People have been taking far larger average withdrawals than originally expected, which has meant much more has been paid in income tax.

'The problem is that we really don't know if this is starting to turn into a major problem or not - there are no systems in place to look across people's pensions in aggregate, so we have little idea of who is taking the money and what they are doing with it.'

This article was written for our sister website Moneywise.

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