It may be hard to believe these days but there was a time when the annual and lifetime allowances were both flexible and simple – leading Jessica List to wonder if a degree of complexity in pensions is inevitable.
It has been a little while since the pensions industry last had a large chunk of draft legislation to work through, readying itself for a big change to the tax rules.
It has also been a while since we were writing articles and factsheets about how a major new rule might work in practice and since we were speculating about how it could help – or hinder – retirement planning.
After a few years of large changes in quick succession, things have gone relatively quiet. Instead, the key focus over the last few months has been speculation about what might happen next.
I appreciate that planning for the future is quite literally what we do, and considering the unknowns is important. I have to admit, however, that over the last few weeks I have grown tired of worrying and I suspect I am not alone.
That is why, when planning this article, I wanted to write about something positive instead. In fact, I had decided to write about being positive. My first thought was that we often bemoan the complexity of pensions, rather than celebrating the broad flexibility that comes from this.
I was almost ready to start typing, when a thought crossed my mind – was I really saying I thought flexible rules had to be complicated?
To start with it seemed to make sense – at least when considering tax rules. A flexible rule might have scope to be misused while conditions added to prevent this from happening lead to complexity. It also seemed reasonable that a generous rule would have criteria to be met, so that it takes planning and effort to take advantage.
Take the current death benefits rules, for example. They team great flexibility with generous tax advantages for beneficiaries, but these come at a price. First, there are restrictions on when beneficiaries can have drawdown, which is often the most flexible option.
Dependants always have the option of drawdown but, for other beneficiaries, it depends on whether they have been named on an expression of wishes and whether there are any surviving dependants. Then there are conditions that must be met in order for a tax-free payment actually to be free of tax. And of course, there are additional rules for beneficiaries who inherited funds before the rules changed …
Another way to demonstrate value
I had always thought of these rules as the trade-off for having flexible and generous death benefits. Advisers have also told me they try not to mind the complexity as it is another way for them to clearly demonstrate the value they are adding for their clients.
But then I found myself thinking about the annual allowance and lifetime allowance. Or at least, the annual allowance and lifetime allowance from a few years ago – before all of the additional restrictions and umpteen rounds of protection.
We had one high annual allowance, which gave investors the flexibility to make large one-off contributions or build up their pension in a short space of time if needed. The lifetime allowance then made sure very high earners could not use the full annual allowance each year to build an enormous tax relieved pension.
Not that the allowances were really in place at those levels long enough for that to happen of course, but you get the idea. Here was an example of rules that were flexible and simple – at least at their inception.
Perhaps that’s the point – many of the current tax rules started off from a simple premise and have since been complicated through multiple small changes and transitional measures for those affected. It is possible to have flexibility and simplicity at the same time but perhaps only if we do not make adjustments afterwards.
Of course, this means there is no easy solution, as making amendments to rules is a natural part of adapting to changing circumstances. If we did not make small changes to existing rules, presumably we would have to introduce a brand new set of simple rules every time something needed to change, which would probably be even more challenging.
Perhaps some complexity is inevitable after all …
Jessica List is pension technical manager at Suffolk Life
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