Removing emergency tax on income drawdown payments is one of the leading tax and pension planning simplifications that advisers feel would be most useful to them and their clients, according to new research by abrdn.
More than a quarter (26%) of respondents to abrdn’s bi-annual survey of 190 UK financial advisers said removing the tax would top their wish list of potential changes, over removing elements such as the tapered annual allowance and the money purchase annual allowance. Overall, the majority of advisers (59%) listed removing emergency tax within their top three priorities overall.
Single or ad-hoc pension payments, or initial payments of regular pension income, are normally taxed on the ‘emergency month one basis’*. This basis ignores a client’s existing income tax position to date and uses a blanket approach which usually leads to an overpayment of income tax for most clients which they need to reclaim from HMRC.
Elsewhere, two in five (39%) advisers surveyed by abrdn listed removing the lifetime allowance (LTA) as their most desired tax and pension planning change, while nearly one in ten (9%) listed the removal of the money purchase annual allowance as their priority reform.
Four per cent wanted to prioritise the removal of the tapered annual allowance as the number one change, while a further four percent wanted to move to a flat rate of pension tax relief as their top simplification priority.
Alastair Black, Head of Industry Change, abrdn, said: “Complexity in legislation and tax structures causes complexity in advice. This is ultimately a barrier to good customer outcomes.
“Emergency tax is clearly one of advisers’ biggest frustrations, and it could be something that becomes more and more of an issue in our current economic environment with an increase in flexible payments growing likely.
“With factors like rising inflation and an increase in the number of people wanting to continue working in retirement, income needs are likely to only vary more and more, potentially meaning more instances of clients making lump-sum withdrawals or changing their regular payments. This could result in being stung by up-front tax charges - which could be up to £1,000s for certain clients - that they would then have to reclaim.
“In addition, if these withdrawals are needed for specific payments they may need to withdraw further income until they can reclaim the overpaid tax.
“The problems that arise from emergency tax are in large part due to it operating on a ‘month one basis’. A move to a cumulative tax basis*, where tax is calculated based on overall year to date earnings would reduce the likelihood of any overpayment, or the need to reclaim.
“It’s also not surprising to see so many advisers wanting to scrap the LTA. Constant cuts to the LTA combined with various protections have added to the complexity of an already complex mechanism, and the LTA freeze will drag more pension savers into the LTA net.
“Despite this, pension saving will still be the most tax-efficient place to save for the vast majority, and the LTA shouldn’t be seen as a ceiling – if net returns on savings in excess of the allowance are still greater than saving elsewhere, then some extra tax could be a price worth paying.”
* The week 1 / month 1 basis gives a proportion of any allowances and rates of tax for each pay period. However, it differs from the cumulative basis in that it ignores previous pay and tax. In effect all payments are taxed as though it was week 1 or month 1 of the tax year.
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Data for abrdn’s Quest report was collected between 18th and 29th May 2022. 190 UK financial advisers who work with abrdn took part in the survey.
Notes to Editors
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