Doctors turning down overtime and taking early retirement because of insane pension regulations have grabbed attention in recent days. But as investors, we are all enmeshed in this tangled web.
Chancellors, tax officials and Treasury bureaucrats, intent on preventing tax avoidance, have created a complex mess, with opaque rules and severe penalties awaiting those who accidentally break them.
Contribute too much in a year, or invest too well over your lifetime, and you could be hit with a 55 per cent tax charge.
Minefield: Chancellors, tax officials and Treasury bureaucrats, intent on preventing tax avoidance, have created a complex mess for pension savers
Higher earners who work paid overtime can lose more in tax than they earn for those extra hours, as doctors have discovered.
In 2015, the Pensions Management Institute published a paper by Ian Neale, a director of consultancy Aries Insight, which estimated we were heading towards 10,000 pages of pension legislation.
At one time we were allowed to contribute up to £255,000 a year to pensions and gain tax relief.
That may seem a lot, but to a small business person selling up at the end of their career, that flexibility could be vital.
Now the annual limit is generally £40,000, but can be as low as £10,000 for higher earners.
This restriction has come from a supposedly enterprise-friendly Conservative government.
It is difficult to imagine how a Labour Chancellor could be more savage.
Former Pensions Minister Steve Webb, now a director of policy at Royal London, recently warned that middle-income workers could face massive tax bills later in life because of a separate limit on the amount we are allowed to hold in a pension.
This lifetime allowance has been slashed from £1.8 million at the start of 2012 to £1.055 million.
This has nothing to do with how much you contribute, or how much tax relief you get, it is simply a sanction on those who invest well.
Mr Webb estimates that 290,000 who are still working already have pensions in excess of £1.055 million and that 1.25 million people are likely eventually to exceed the lifetime limit.
He says: ‘HMRC seems to be far more interested in stopping people putting money into pensions than in encouraging them to save more.
‘The rules are designed to catch the minority who might abuse the system but end up penalising the majority who have to deal with the resultant complexity.’
The cuts in the lifetime allowance have led to enormous complexity for those who had already built larger pensions.
At one time we were allowed to contribute up to £255,000 a year to pensions and gain tax relief. Now the annual limit is generally £40,000, but can be as low as £10,000
They were told they must stop contributing and apply for protection, otherwise part of their pensions could face a 55 per cent tax charge. That’s the situation I found myself in a few years ago.
Meanwhile, those on the brink of retirement who hold multiple pensions are stumbling through hastily constructed, ill-thought-out rules that were supposed to stop them recycling pension money.
The Money Purchase Annual Allowance (MPAA) is supposed to prevent people taking a large sum from a pension and then reinvesting in a new one to get further tax relief.
It only applies to defined contribution pensions — those where you invest in the stock market so you know what you are paying, but not what you will receive.
The rules are that if you take one pension then you are only allowed to invest up to £4,000 a year in another. But there are exceptions.
A friend has an old pension policy that promises a 9 per cent-plus income. He wants to take it and the tax-free lump sum now.
The complication is that he also wants to continue contributing to a self-invested personal pension (SIPP).
He asked his financial adviser if he would fall foul of the MPAA recycling rules. His adviser asked the pension company twice — and got a different answer each time.
In fact, Steven Cameron, pensions director at Aegon, says he should be fine as, apparently, the MPAA is not triggered if you take a tax-free cash lump sum and buy an annuity that provides a guaranteed income for life.
But why should investors, advisers and companies be left to interpret tax rules that are so devilishly complex and carry such onerous penalties for non-compliance?
Mr Cameron says: ‘The biggest concern is that some people might not realise that by cashing in one pension, they could become subject to the MPAA and then find they can’t pay above £4,000 into another pension.
‘The £4,000 limit includes personal, third-party and employer contributions, so they could also find they have to turn down a contribution from their employer in a future workplace pension.’
The problem is that these rules are designed by MPs and civil servants who benefit from guaranteed pensions linked to their salaries and subsidised by taxpayers.
They have no concept of the difficulties and costs most people face saving for retirement, and then making decisions on how best to take that income.
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