Ahead of the Spring Budget set to be delivered by Chancellor Jeremy Hunt, AJ Bell personal finance experts set our six policy options for the government which could simplify the tax system for households and remove barriers to work and savings.
- Address the pension tax rules deterring workers from returning to the labour market
1.a The Money purchase annual allowance (MPAA)
The government has stated on numerous occasions its desire for older workers to return to the labour market. However, the money purchase annual allowance (MPAA) directly contradicts this objective by penalising people who return to work if they have already taken flexible income from their pensions.
When someone aged 55 or over withdraws taxable income flexibly from their retirement pot, they become subject to the (MPAA). In most cases, this will be where someone takes income via drawdown or withdraws an ad-hoc lump sum directly from their retirement pot.
The MPAA not only reduces their annual allowance to just £4,000, but also removes the ability to ‘carry forward’ any unused allowances from the three previous tax years. Taken to its limit, this means someone who flexibly accesses £1 of taxable income from their pension could be subject to a 97.5% cut in their annual allowance for the 2022/23 tax year, from a possible £160,000 to only £4,000.
Those subject to the MPAA face an annual allowance tax charge if their contributions exceed this limit.
AJ Bell asks: AJ Bell is calling on the government to immediately increase the MPAA back to £10,000, the level at which it was first set, and over the longer-term consider replacing it with rules similar to the ‘unauthorised payments’ rules which prevent recycling of tax-free cash.
AJ Bell head of retirement policy Tom Selby says:
“There is a growing body of evidence that the number of people accessing their pensions in response to inflationary pressures is rising. The most recent set of retirement income statistics from the FCA show the number of retirement pots accessed for the first time in 2021/22 rose by 18%, from 596,080 to 705,666.
“HMRC data, meanwhile, tells us £3.6 billion of flexible pension withdrawals were made between 1 April and 30 June 2022 – a 23% increase compared to the same period in 2021. This is likely to be a response to the rising cost of living.
“Punishing those who access their retirement pot flexibly with such a swingeing cut to their annual allowance is deeply unfair and will leave many hamstrung when looking to rebuild their pension after this crisis.
“This penalises anyone that takes early or partial retirement and takes money from their pension pot, but who may later choose to return to work. Likewise, those that take money from their pension pot now to help themselves or their family fight rising costs will find their rights to build up future pension savings slashed.”
“To send out a message to hard-working savers that the government is on their side, we recommend the Treasury should, as a minimum, increase the MPAA to £10,000 as soon as possible. This is the level the MPAA was originally set at in April 2015, when ‘pension freedoms’ were first introduced. As far as we are aware, the decision to cut the MPAA to £4,000 was not based on any evidence of pensions ‘recycling’.
“The 2016 consultation simply said the Treasury “does not believe a £10,000 MPAA is needed or appropriate on an ongoing basis”. The analysis supporting this focuses on the maximum someone could save if auto-enrolled at the minimum of 8% of band earnings – an approach which does not account for the need to make up for lost time. It was also undertaken at a time when inflation and interest rates were relatively low and stable.”
1.b The lifetime allowance (LTA)
The lifetime allowance also risks becoming an increasingly significant deterrent to those considering returning to the workforce.
It is among the primary reasons some senior NHS staff have decided to retire early and the longer the lifetime allowance (LTA) is frozen at its current level of £1,073,100, the more it will start to impact on the decision-making of other workers in both private and public sector.
More broadly the LTA penalises diligent long-term investing in Defined Contribution (DC) pensions and is an unnecessary complication, given that the cost of pension tax relief is already controlled by the annual allowance.
AJ Bell ask: As a minimum, the government should reconsider its decision to freeze the LTA until 2026 and instead uprate the threshold with inflation.
The Treasury should also assess the impact pension rules are having on the workforce and savings incentives, ideally as part of a wider review aimed at simplifying the pension tax system and encouraging greater levels of retirement saving. This should include serious consideration of whether the lifetime allowance should be scrapped altogether for defined contribution (DC) savers.
AJ Bell head of retirement policy Tom Selby says:
“The lifetime allowance stood at £1.8 million in the early 2010s, while the annual allowance was £255,000. Successive cuts to both were designed to raise money for the Exchequer but had little thought for the interaction they might have with the labour market.
“Tinkering by successive governments has resulted in the UK having a mind-boggling set of allowances designed to control the cost of pension tax relief.
“These include the annual allowance, money purchase annual allowance, tapered annual allowance, non-earners allowance, lifetime allowance and seven forms of protection associated with the lifetime allowance. This complexity is incredibly difficult to navigate, risks putting people off saving in pensions and hinders effective communication.
“An independent review of the pension tax system, with the dual aim of simplifying the system and encouraging more people to save for retirement, could help achieve consensus on building a framework that is fit for the future.”
- Simplify ISAs through a ‘One ISA’ tax wrapper to supersede the multiple ISAs currently in circulation
Lack of understanding is one of the biggest barriers to saving and investing. While the concept behind Individual Savings Accounts (ISAs) is simple – a savings account in which people can hold cash or stocks and shares without having to pay tax on interest, dividends or capital gains – layers of complexity have been added through government tinkering.
AJ Bell ask: Simplify the ISA system through the introduction of a ‘One ISA’ tax wrapper to supersede all existing ISA account types.
AJ Bell head of policy development Rachel Vahey says:
“Through multiple Government interventions we now have at least six variations of ISAs which all aim to cater for slightly different customer needs. This risks creating a level of complexity that puts people off saving and investing if they’re unable to get past the first hurdle of simply choosing the right product for their needs.
“Pensions were simplified seventeen years ago. We are now in desperate need of ISA simplification to nip this issue in the bud before the list of different ISAs available grows so lengthy that some prospective savers find themselves suffocated by choice and complexity.
“The One ISA system could support a range of different government-funded bonuses designed to encourage and reward certain savings behaviours. As well as a bonus for first-time buyers, a government top-up could be applied for people using their savings to fund long-term care, childcare, education or retirement.”
How ISA simplification could work
All existing ISA accounts types should superseded by a single, all-encompassing ISA, which AJ Bell refers to as ‘One ISA’.
Transitional arrangements would need to be carefully considered to avoid any detriment to existing product-holders using one or more of the ISA account types in circulation today.
Once accomplished, this would radically simplify the UK’s savings and investment market, removing the complex web of decisions which discourages many people from saving and investing today.
It would also permit a system of flexible government bonuses, similar to today’s Lifetime ISA bonus, which could be used to reward and incentivise savings goals including retirement, funding long-term care and education costs.
One ISA bonus system
If the One ISA becomes the primary mechanism of saving then the Government can use bonus incentives to influence and encourage certain behaviours.
Support for first time buyers is already encompassed within the existing Lifetime ISA and could be replicated under One ISA.
Other behaviours the Government may wish to encourage using ISA bonuses could be repayment of student loans, childcare funding, specific vocational training, retirement funding for the self-employed or long-term care.
With this structure in place, bonus eligibility could then be linked to subscription years, and the age of the One ISA account holder, allowing for better targeting than is currently possible and rewarding those that save invest for the long term.
We propose that the bonus is calculated as 25% of the ISA funds used for the specified purpose, with a maximum of £1,000 for each “subscription year”. The bonus would be paid at the point of using the ISA funds for the specified purpose e.g. for first house purchase, at the point of paying the deposit.
- Tackling flaws in the Lifetime ISA
Over the long-term we would like to see simplification of the ISA landscape (see above), but within the existing system the Lifetime ISA (LISA) has two clear flaws which need to be addressed: the punitive exit charge and the frozen limit on the maximum value of a house purchased using a LISA.
AJ Bell ask: Reduce the early exit charge to 20% and increase the limit on the value a house purchased to £600,000.
AJ Bell head of personal finance Laura Suter says:
“The level of the exit charge at 25% means it not only returns the upfront government bonus but also applies an additional 6.25% penalty. Hitting savers with this penalty is unfair, particularly given the severe financial strain millions of people are set to face in the coming year.
“The Treasury acted to temporarily reduce the early exit charge from 25% to 20% during the pandemic. It should make this move permanent at the Budget.
“The house price limit hinders aspiring homeowners, especially those in the south east who in some cases will find the home they want exceeds the £450,000 threshold, which has remained unchanged since the product was created in April 2017.
“Since then, average property prices have increased around 35%, meaning the ability of people to use LISAs for the purchase of a first home has been diminished.
“The LISA property price limit should be increased to £600,000, broadly in line with house price growth in the last six years.”
- Save parents from a tax headache as interest rates rise by raising the tax-free threshold on children’s savings
Rising interest rates threaten to drag unassuming parents into a complicated tax headache.
Children’s savings are tax-free up to £100, but once interest exceeds this level in any tax year the parent is liable to pay tax on the interest if it exceeds their own personal savings allowance.
Many parents won’t realise that interest on children’s savings is taxable and may fail to declare it, potentially facing a penalty as a result.
AJ Bell ask: Raise the tax-free limit on children’s savings to £500, meaning anyone with savings for children under £10,000 should not be caught in an unexpected tax trap.
Laura Suter, AJ Bell head of personal finance says:
“Parents haven’t had to worry about this little-known tax rule while savings rates have been abysmally low, but now they are creeping up they could find HMRC comes calling for unpaid tax. It’s annoying that parents who have diligently saved for their children might find their good deed has a tax sting at the end of it, but if they get savvy now they could avoid the tax hit.
“Savings rates on all accounts, including children’s versions, have shot up since the Bank of England raised the base rate, with the top two-year fixed rate kids account paying 4.4%* – so once savings reach £2,250 you’ll hit that £100 limit.
“One way around this pesky tax rule is getting friends or family to contribute to the accounts instead. Any interest earned on money paid in by other people, including friends and grandparents, doesn’t count towards this limit.
“The other option is using ISAs, as interest earned on ISA accounts isn’t taxable. You can pay in up to £9,000 per child into an ISA each tax year, which means anyone who has built up decent savings outside an ISA can transfer up to that amount each year. Unfortunately, the rates on cash JISAs often aren’t as good so you’ll need to work out if the tax saving is worth it.
“Alternatively, you could consider investing in a stock and shares JISA. Lots of money saved for children sits in cash accounts, but really if you’re saving for 10, 15 or even 18 years that’s the ideal time horizon for investing. Investing is your best bet for ensuring your child’s savings beat inflation over the long term. You can open a Junior ISA in their name, which will become theirs when they turn 18, or you can choose to invest the money in your own ISA, if you have some of your annual limit left.”
- Remove stamp duty charges for investors
Investors purchasing investment trusts face an uneven playing field compared to those using funds and exchange-traded funds (ETFs).
The Stamp Duty Reserve Tax (SDRT) applies when investors buy UK shares and is levied at 0.5% of the transaction.
It doesn’t apply to funds (unit trusts and OEICS) or ETFs, creating an uneven playing field when it comes to the way investors are taxed.
Over £4.3bn was paid in stamp duty by investors in 2021-22.
AJ Bell ask: Level the playing field for investors by abolishing SDRT on investment trusts.
Kevin Doran, AJ Bell Investments managing director says:
“Funds, ETFs and Investment trusts all do a similar job for investors and yet when it comes to stamp duty, only one of these – the good old investment trust – sees investors hit with stamp when they buy the trust itself. For the other collective investments, there’s an understanding that fund managers will pay stamp on the purchases they make within their funds and so are exempted from this double taxation. In the interest of fair play, it’s about time the playing field was levelled for Investment Trusts as well.”
- Overtaxation of pension withdrawals
Since 2015, the HMRC has chosen to tax the first flexible withdrawal someone makes in a tax year on a ‘Month 1’ basis.
This means the Revenue divides your usual tax allowances by 12 and applies them to the withdrawal, landing hard-working savers with shock tax bills often running into thousands of pounds.
While those who take a regular income or make multiple withdrawals during the tax year should be put right automatically by HMRC, anyone who makes a single withdrawal will likely be left out of pocket.
This is a long-standing issue that has been a concern since the introduction of pension freedoms in 2015, although the apparent increase in the number of people accessing their pension for the first time will exacerbate the issue.
AJ Bell ask: Urgently review how flexible withdrawals are taxed and set out a timetable for creating a system which taxes people correctly.
AJ Bell head of retirement policy Tom Selby says:
“It is almost eight years since the pension freedoms were introduced and the tax system still hasn’t caught up. In fact, there has been no formal review of the current approach, which colossal overtaxation of ordinary Brits.
“When you are overtaxed by the Revenue it is possible to get your money back within 30 days, but only if you fill out one of three HMRC forms to reclaim your money. If you don’t, you are left relying on the efficiency of HMRC to repay you at the end of the tax year.
“A staggering £45 million was repaid to savers in the final three months of 2022 – the highest Q4 figure on record and third highest since the pension freedoms were introduced in April 2015.
“The total overtaxation figure has now reached £970 million and will inevitably pass the £1 billion landmark in 2023.
“Depressingly, the true scale of the issue is likely much higher as many of those who have been overtaxed – in particular, people on lower incomes who are less familiar with the self-assessment process – will not go through the official process of reclaiming the money they are owed. As a result, they will be reliant on HMRC putting them right.
“It is ridiculous the tax system operates in this way and scandalous that the government has done nothing to address it almost eight years since the pension freedoms were introduced.
“HMRC should instigate an immediate review of the way flexible pension withdrawals are taxed. There is a real danger people are being pushed into hardship by the current approach, and we need to rapidly move to a system where the right tax is paid on withdrawals when they access their money.”