Articles - Pension saving trumps inheritance tax reform

The Institute of Economic Affairs (IEA) have proposed that Inheritance Tax (IHT) be abolished. The IEA feels that the tax is a big disincentive for people to save, as it hinders them from passing on the accumulated wealth to their offspring. The idea of inheritance tax is always a controversial one. Those against say that IHT penalises savers who want to provide for their kids while those in favour believe it should be looked at from the recipients’ side.

 By Tom Murray, Head of Product Strategy for LifePlus Solutions at Majesco.


 They ask why some people should receive tax-free sums whilst those not lucky enough to have been born into wealth pay tax on all their income. 

 The argument will no doubt rage back and forward but what is interesting about the Institute’s proposal is the fact that they believe the abolition of IHT should be made revenue-neutral for the government. It is proposing the abolition of the 25% tax-free lump sum (TFLS), which is allowed to people taking their pensions. This is a dramatic move as the policy of all governments over the last few decades has been focused on driving up the numbers saving for their retirement, reaching its peak with the introduction of the workplace pension schemes and auto-enrolment of the workforce into it.

 When it comes to pension savings, the TFLS is one of the best known and most appreciated benefits. It is an important driver for many to start and maintain their savings rates, with an easily understood promise and without the ‘risk’ of losing out by dying earlier than the actuarial norm.

 For many people, it is the TFLS that is the most attractive benefit of pension saving and the easiest to understand the value of, with its promise of a large amount of money at the very start of their retirement. Lots of workers have this earmarked to either clear outstanding debts or embark on a well-deserved holiday or cruise to mark the end of their working life.

 The ability to clear any outstanding mortgage is particularly appreciated as, given that for the majority of people income drops in retirement, the repayment of their outstanding mortgage is key to their plans for having a secure future in their old age. It also gives comfort because they feel that they are now in full ownership of a substantial asset – an asset that it will be possible to release equity from should the need arise. This can be done either via an equity release product or by selling the house / apartment and downsizing. This ability to realise a lump sum at relatively short notice gives them much reassurance against the fears of a sudden need for capital in their old age, such as might arise from a severe health issue requiring care or the need to move into a nursing home.

 The UK has made great strides in recent years in increasing the proportion of the population saving for their own retirement. The auto-enrolment process has encouraged almost 10 million people to begin taking control of their own future by investing in a workplace pension. However, this saving habit is recent and may well be fragile. Risking it by changing something as popular as the tax-free lump sum given at retirement would be a very retrograde step.

 Instead we should be focusing on further ways to increase the amount people are saving. One of the best ways we can do this is to use technology to keep people far more in touch with their savings and allow them to monitor their progress on a regular basis. But it has to be about much more than just showing them what’s been saved so far.

 The tax-free lump sum pays a key part in this, given its attractiveness and how easy it is to understand. The key to maintaining and increasing retirement savings levels will lie with clever apps that give the employee projections of what they will have in the future if they maintain their savings. In this regard, showing them the size of the lump-sum, they will be entitled to take at retirement will be very important, as will showing them the effect on said lump sum of small increases in the amount being saved. This would show a dramatic increase, particularly for those who are in the early stages of their career, those whom it is generally harder to get interested in retirement saving.

 To keep people saving, the government need to ensure that retirement saving is seen as a highly attractive option for people making decisions on their finances. The TFLS is a key part of this. Proposals for the abolition of the TFLS should not be entertained; if the IEA feel the need to recommend the removal of IHT, they should find another way to pay for it.


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