Financial illiteracy blamed for growing pensions tax take

The Organisation for Economic Co-operation and Development (OECD) has revealed that the lack of knowledge surrounding the current pension freedom arrangements has allowed the UK Government to collect more taxes than anticipated.

The OECD Pensions Outlook 2018 found that financial literacy, which affected pensions withdrawal behaviour, was at the heart of this increased tax take.

It states that individuals “may not understand the consequences in terms of taxes paid of withdrawing funds from their pension account.”

Introduced in 2015, the pension freedoms give savers with defined contribution pensions the option to withdraw their funds from age 55, subject to tax paid at their marginal rate, which may be considerably lower than the 55 per cent previously charged.

The Government had initially estimated revenue of around £0.3 billion in 2015/16 and £0.6 billion in 2016/17 from this new system. However, the actual figures for these years show that it raised £1.5 billion in 2015/16, while the latest estimate for 2016/17 was £1.1 billion – far more than was originally anticipated.

The Office for Budget Responsibility (OBR) has estimated that the Government will also raise £1.6 billion in 2017/18, and £1.3 billion in 2018/19 through the pension freedom system.

In light of its findings, the OECD has suggested an appropriate default post-retirement product should include a combination of programmed withdrawals, offering flexibility during the first years in retirement, with a deferred life annuity for the later years.

These would be similar to the easy access ready-made drawdown investment products that the Financial Conduct Authority (FCA) is currently considering, which would force providers to comply with a simplified system to aid financial literacy.

In response, advisers have warned against a “one size fits all” approach towards calculating drawdown rates and argues that saver should be offered bespoke solutions.

Link: OECD Pensions Outlook 2018