Pension payouts for lower-paid workers hit by tax changes

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Pension payouts for lower-paid workers hit by tax changes

By Nicholas Timmins, The Financial Times

December 15, 2003

People with some of the smallest occupational pensions in Britain face a 35 per cent "stealth tax" if they die within five years of starting to draw their pension, the Engineering Employers' Federation warned yesterday.

"I find it hard to believe that the government really intends this," David Yeandle, pensions specialist at the EEF, said. "But that is the effect of what they are proposing.

"This will hit lower-paid manual workers particularly hard as they are statistically much more likely to die within five years of retirement than people higher up the income scale."

Under many occupational pension schemes, members have a guarantee of five years' worth of pension when they retire.

If they die within that time, their widow or widower gets a tax-free lump sum equal to the pension less any money that has already been paid out.

Under the "tax simplification" proposals announced last week, that lump sum would be taxed at 35 per cent, the EEF said.

Mr Yeandle said the move appears to be an unintended consequence of the government's drive to stop the very well off - so-called fat cats - assembling large tax-advantaged pensions and being able to pass the capital in them on untouched if they die early.

For someone drawing a £50-a-week pension who died three years after retirement, the tax would cut the lump sum from £5,200 to £3,480 - cash that employers say could help with funeral costs and provide a bridge to the lower widow's pension.

The EFF warned pension ministers and the prime minister's advisers at Downing Street about the impact of the measure during consultation over the tax simplification proposals. But the federation says it has appeared unchanged in last week's announcement.

"Employers are saying they will have to write to all members in their schemes telling them about this, which is hardly going to encourage people do more pension saving," Mr Yeandle said.

"It is terrible PR. It hits the people with occupational pensions that you would think that a Labour government would be most concerned about.

"And it is ironic that it is being done in the name of tax simplification - to the vast majority of people it will look like the opposite of that."

There were, he said, two options. "The government could stick with the status quo, which would be the simplest. I don't know the figures but there cannot be that many really wealthy people who die within five years of retirement that the government would need to catch.

"Or it could set a limit on the amount that can be paid over tax free."