A] Prelude
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https://expatpensionholland.nl/uk-expat-pensions
https://expatpensionholland.nl/global-pillars-systems
https://expatpensionholland.nl/global-investments-risks-0
https://expatpensionholland.nl/global-social-security-coverage
B] The Issue
Why save for retirement when you’re headed for just another tax hit? Labour’s recent budget profoundly altered the UK’s pension landscape, but the full significance of its impact has yet to be recognized.
Before Chancellor of the Exchequer Rachel Reeves cracked down, the government was effectively providing generous tax breaks (of up to 45%) to enable the wealthy to salt away millions into their pensions, which could then be passed onto their heirs entirely free of inheritance tax (IHT).
It was an estate planner’s dream to have the taxpayer subsidize a vehicle that not only dodged capital gains tax but also provided immunity from the ultimate fiscal arbiter. Of course it was all too good to be true, especially when faced with a government desperate for cash to fund an ambitious spending program.
However, in closing this iniquitous loophole and ending pensions’ exemption from inheritance tax, the chancellor is changing incentives in unhelpful and unanticipated ways.
C] Side effects
The most tangible is that pensions are now materially less attractive than many investments, such as property. Both the current and previous governments sought to discourage mom-and-pop landlords with increasingly onerous regulatory and fiscal measures. The latest budget underlined this by raising stamp duty to deter further property investment, while declining to raise capital gains tax on sales, which might have locked in these small landlords by making it too expensive to sell.
Economically, though, for many small investors, real estate might once again appear to be a relatively attractive savings vehicle for retirement. Although buying an investment property (or a second home) doesn’t attract initial tax relief in the manner of a pension, the ability to leverage a long-term investment with a mortgage more than compensates for that. A modest 10% rise in the value of a £1 million ($1.26 million) property with a 90% mortgage would double the owner’s equity from £100,000 to £200,000.
D] Passing away effect
The more interesting comparison, though, is what happens upon the owner’s death after April 2027 when Labour’s changes come into force.
An inherited pension of £1 million would attract an immediate tax bill of £400,000 (IHT at 40%), leaving the heirs with £600,000. However, in order to draw upon their fortune, the recipients would be required to pay income tax on the £600,000 at their marginal rate. With tax thresholds frozen in 2021 and set to remain locked until at least 2028, that is a significant and escalating burden.
A family inheriting the aforementioned investment property would also pay IHT of £400,000. However, they would then be free to sell that property and realize the full £600,000 immediately with no income or capital gains tax to pay. This is just one example of how careless policy can alter investor behavior in profound and unintended ways.
E] Options
Those with access to the best financial advice have other options that have now also been elevated above pensions, such as Enterprise Initiative Schemes (EIS), which can offer upfront income tax relief, deferral of capital-gains tax and, ultimately, a degree of inheritance-tax protection too.
Perhaps the most significant change in behavior, though, will be qualitative rather than quantitative, undermining people’s faith in investment in general and pensions in particular.
Ever since Gordon Brown abolished the dividend-tax credit for pension funds in 1997, raising £5 billion a year, almost every chancellor has felt the need to introduce major new measures, which have impacted investor behavior to the detriment of pension provision. Reeves took this to another level by completely reversing incentives in an economy in desperate need of stable, long-term funding.
F] Finally
On an individual level, pensions are a social contract where young workers, encouraged by tax relief, agree to part with their money over the course of 40 or 50 years for a risky and unspecified return.
Anything that undermines that faith will inevitably make it more difficult to persuade those who are already struggling with the cost of living to lock away their hard-earned cash.
And should they, despite all these obstacles and disincentives, still commit to pension savings, accumulating a decent pot in the process, there is a final twist when they die.
With residual pension savings now included in a deceased person’s taxable estate, those funds can’t be accessed until the inheritance-tax bill has been settled. Thus, Reeves has made even benefiting from what’s left of a pension pot after someone has died subject to possibly the two most burdensome and inefficient administrative processes known to humanity, pensions and probate.
The immediate post-budget debate has been framed in terms of the incentive of the well-paid to become economically inactive by retiring early and gifting surplus income. The bigger picture is that the investment landscape for everyone has changed and has done so in direct opposition to many of the government’s most cherished goals — such as positioning pension funds as investors in UK infrastructure and deterring property investment.
Aligning incentives with objectives is a key element of good policy and the very last thing the UK needs right now is to undermine the most efficient means of applying the nation’s long-term savings to promote growth. So, perhaps reports of the death of pensions may have been exaggerated, but the damage done to Britain’s investment culture may yet prove fatal.