Yesterday, the Chancellor announced his decisions on the consultation following the Budget reforms to pensions. One important aspect that received much less attention than others was how the reforms will work from a tax perspective.
First a few words about the overall picture. The Government has taken sensible and pragmatic decisions about the implementation of the reforms. On guidance, the Treasury will hold overall responsibility for the service design and implementation of the guidance guarantee until the guidance service reaches maturity, and will work with a range of organisations, including the Pensions Advisory Service and the Money Advice Service, to deliver the guidance service. A Treasury team will lead this work, bringing in specialist resources from across government and TPAS and MAS. We believe this will mean that delivering the guidance guarantee, while still a monumental task, can be achieved by next April, and we will continue to support Government in this important work in every way we can.
But the complex pension tax consequences of the Budget have somewhat slipped under the radar. As Alistair Darling wrote in his memoirs: "In tax matters, the devil is in the detail, and you cannot safely make big changes in a hurry without thinking through the consequences for taxpayers at every level."
The same thinking has been necessary here: the fundamental changes to the retirement tax framework could have created significant opportunities for individuals taking unfair tax advantages but, with effective industry engagement and much detailed work, the right balance has been struck by Treasury.
The potential unfair tax advantage arises because the new simplified tax rules from 2015 mean that individuals over 55 could divert their salary or a large part of it into their pension every year, take it out immediately and receive 25% tax-free, thus avoiding both income tax and National Insurance Contributions on their employment income. They could then also re-invest the tax-free element into another pension, again gaining a quarter tax-free on withdrawal. Clearly, this would have significantly undermined the intentions of the reforms.
This presented a dilemma for Government - how to balance flexibility for individuals against the need to protect the Exchequer from abuse, and to ensure that any solution could be delivered for 2015.
We believe the solution presented yesterday strikes the right balance between these potentially conflicting goals. Effectively, once an individual has made use of the new flexibilities (i.e. drawn down more than their tax-free lump sum), they will still benefit from tax-incentivised pension saving, but their annual allowance will be reduced to £10,000.
This makes it clear that people can't exploit the Budget reforms by using them for tax planning purposes by avoiding tax on earnings. At the same time, it ensures that individuals can safely access an existing pension pot flexibly (for example, because of redundancy or ill health, or because they want to support their children) but still save into a pension later.
This is critical if we want to support our ageing society with more flexible paths into retirement, and encourage people to work and save for longer. We also know from surveys that people feel more attracted to pension saving as a result of the Budget - the annual allowance solution to pension recycling, while still a restriction, should not detract from that, and will support the Government's wider policies about working longer and saving more.
Crucially, reducing the annual allowance for savers who have accessed flexibility goes with the grain of consumers' understanding of how the system works at the moment and does not expose consumers engaged in normal saving behaviours to the risk of inadvertently being caught by rules designed to prevent tax avoidance. It also is a solution which the pension industry is able to implement within what is a very short timeframe. It will still require a huge effort for an already stretched industry, but creates much less operational risk than more complex solutions. And it is a reasonably simple fix - the new guidance service will have a much more straightforward job explaining to people how it works.
We will continue to work with HM Treasury on the detailed tax legislation that will implement these changes but it is only fair to say that this is a very good example of a Government consulting effectively and delivering an outcome which is good for consumers and workable for the industry.
Yvonne Braun is Head of Savings, Retirement and Social Care, Association of British Insurers (ABI).