TO SAY THAT the UK government’s announcement that it was going to allow all retirees from defined contribution (DC) schemes to take all their money as tax free or taxable cash came as a shock to the pensions industry is an understatement. While many had campaigned to allow those in defined contribution schemes (like in Ireland) access to a drawdown product (or Approved Retirement Fund), few expected the UK government to go as far as they did.
So what exactly did the UK government do? Well, they eliminated the requirement for DC retirees to purchase an annuity. This is good news given annuity rates in the UK were almost as bad there as they are here, making it a very expensive option for most people. As UK pensions minister Steve Webb says, savers should be free to buy a Lamborghini if they wish – but that if they squander the money they’ll only have the state pension to live on. There was also an argument that the money would go to fuel yet another property bubble.
Now that the dust has settled, it looks that the reality, according to advisers, is that there will be a boom in people investing in the UK equivalent of approved retirement funds (ARFs) as people leave their cash in their pension after retirement, taking some each year to avoid falling into 20 per cent or even 40 per cent tax and putting that in tax-free Isas or, higher up the scale, Enterprise Investment Schemes (the equivalent of our ESIS scheme).
From April next year it is expected that retiring savers will continue to be able to take 25 per cent of their pension pot tax free, then access the rest of their money as cash. But they will have to pay tax on that at their marginal rate – which means they will lose a minimum of 20 per cent, and as much as 45 per cent, to the taxman. Buying property with a pension pot may not be as simple as many predict.
Why would the UK government do this? The altruist in me says that it is because they wanted to liberalise the market to make pension provision more meaningful for those in DC schemes, and to make pensions more attractive for those now caught through auto enrolment. The cynic in me says that the UK government was looking to front load tax income due on pensions because people take the taxable cash.
Some initial estimates show the UK government enjoying net taxable inflows due to the change for the next 10 years and then a negative impact thereafter. These estimates though could be ambitious if most people look to minimise the tax hit.
What’s the situation like in Ireland? This week Labour TD Anne Ferris introduced a Bill in the Dail to end the compulsory retirement age. The State retirement age is moving towards 68 but most companies are looking for employees to retire at the age of 65. Clearly, there is a disconnect between government and private sector policies and this will have to be looked at over the coming years, especially as many over 50s are now looking at options following their primary career.
Set against this backdrop, would our Government do something similar? Unlike the UK we had already scrapped compulsory annuities for those in DC schemes a couple of years ago and people can already draw up to €500,000 in tax free and taxable income on retirement – a sizeable amount in anyone’s books.
In addition, we ensure that when setting up an ARF people have a minimum income of €12,700 or they put away money of €63,500 until they are 75. This all appears to make sense. The only reason that the Government would change these provisions to allow further taxable cash drawdowns at retirement would be if they wanted to front load their tax take. While this is possible, I don’t believe the Irish Government will do this.
Firstly I don’t think many people would have that level of pension income to draw down and so the impact on tax would be small and, secondly, I think the Government gets much easier money from the pensions levy which will bring in approximately €675 million in 2014. This money flows into the government coffers without any change in tax policy and at this point it looks unlikely that the levy will disappear or even reduce in 2015.
I think it’s unlikely that the Irish Government will be funding any Lamborghini purchases for DC retirees any time soon.
Samantha McConnell, Chief Investment Officer, IFG Corporate Pensions
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