The government’s prediction of an additional £320 million in tax is in danger of proving a gross underestimation; judging by all the data we have seen so far it looks as if the Chancellor is in line for a very tasty windfall. From Tom McPhail, Head of Retirement Policy.
Any investor looking to take advantage of the pension freedoms should make sure they have allowed for the tax deduction. They should also bear in mind that the tax taken on day one is not necessarily going to be the actual tax due; in many cases it will involve an overpayment which will have to be reclaimed subsequently. At the time the Pension Freedoms were first announced, in the Budget of March 2014, the government projected that it would raise £320 million in additional tax in the 2015/16 tax year. Since then, the FCA has confirmed that 204,581 people took advantage of the pension freedoms in the first 3 months. The majority of people using the pension freedoms used the UFPLS rules (120,688), under which 25 percent is automatically paid tax free, with the balance being taxed at the individual’s marginal rate.
Separately, the ABI has reported that the average lump sum payment has been £15,000. Assuming (for the sake of argument) that each individual paid basic rate tax on 75 percent of such a withdrawal, they would suffer a deduction of £2,250. With over 200,000 people already having used the pension freedoms in the first 3 months, on a pro-rata basis across the year, the government’s projection of a £320 million exchequer gain would imply an average tax charge of only around £400 per person. It should also be noted that in the majority of cases, the tax taken on day 1 will not be the actual tax which is due. This is because of the use of emergency tax codes and the necessity of making retrospective adjustments.