El Espirito de la Colmena and other pension ephemera
I thought weíd really made it when a friend sent me a link to a website that was going on about ĎThe Spirit of the Beehiveí. When I went to the site it turned out that it is just the title of a famous Spanish film (El Espiritu de la Colmena) that has made it into the top fifty of a must-see list of important films. Never mind, one day the BeeHive might make it into a similar list of must-see websites. Although as itís about pensions I suppose Iíve got to be realisticÖ
Anyway itís been pointed out to me that some of my recent BeeLines have been getting a bit on the heavy side and it would be good if I could lighten up a bit. So this oneís going in that direction I guess and Iíll use it to cover loads of small stuff that Iíve picked up over the last few weeks that are too inconsequential to make it as BeeLines on their own, but might go down OK in a bunch.
First off, a few people have written in asking us to clarify one of the new A-Day rules, that of individuals being able to pay in tax-relievable annual amounts up to 100% of earnings into a personal pension from next April onwards. Weíve all known about this for some time now, but there seems to be some confusion over what "100% of earnings" actually means.
Some have taken this to mean that someone earning, say, £35,000 will be able to pay in £35,000 as a net amount to their personal pension and get an extra £9,871 added in tax-relief, giving a total investment of £44,871. On the other hand, others have been saying that the most someone earning £35,000 will be able to pay in would be £27,300 (78% of £35,000) and that would be grossed up by the addition of tax-relief to the maximum of £35,000
And the winner is? Well, itís the latter one Iím afraid. The most anyone earning more than £3,600 a year will be allowed to pay into their pensions in any one year and get tax-relief is effectively 78% of their annual earnings and this is also effectively subject to an overall limit, the ĎAnnual Allowanceí, of 78% of £215,000 (£167,700).
People with no earnings, or earnings under £3,600 in a year, will be able to put £3,600 into a personal pension. In this case, again, the maximum they can pay in is 78% of £3,600 (£2,808) and the tax-relief is added even if they are non-taxpayers.
Although Iíve only covered personal pensions in these simple examples, the various maxima apply to all contributions made towards pensions in any year. Someone paying into a personal pension and a company pension scheme, for instance, wouldnít get a separate tax-relievable allowance for each. I know itíd be good if they could, but they canít.
The second thing that regularly hits the BeeHive mailbox is this issue of 55% tax being charged on excess monies over the Lifetime Allowance. The Lifetime Allowance, as you know, will be set in 2006 as being pension assets valued at £1.5 million, and is the maximum size of pension pot Government will allow people to accumulate in future unless, of course, theyíre happy to pay tax at a rate of 55% on any excess.
Now Iíve said that a number of times in various BeeLines and in my many presentations when Iím traipsing round the country. Iíve also had no end of people say to me that So-and-Soís website, or some famous guru or another has said that itís not always 55%, but sometimes itís only 25% and what do I think about that? Well, itís true that the ĎLifetime Allowance Chargeí can be either 55% or 25%. Thatís what the 2004 Finance Act said and thatís whatís been reprinted in countless summaries of what the 2004 Finance Act said. Itís correct, but just reporting it is missing the point I think.
For the record, the Lifetime Allowance Charge is 55% on funds over the Lifetime Allowance if they are taken as a lump sum, but it is 25% if the funds are taken in the form of a pension.
What this means is that if income is taken with excess funds the funds are docked by 25% and then the income payable is taxed, probably at 40% given that people with funds at this kind of level will be higher-rate taxpayers. So if you start of with £1,000 over the limit and it is has the Lifetime Allowance Charge applied to it what will happen is if the excess fund of £1,000 is taken as cash £550 will be taken as tax first leaving just £450 for putting in the back pocket. On the other hand if the £1,000 is used to provide extra income it will first get hit with a 25% Lifetime Allowance Charge, which will leave only £750 to buy extra income with. That extra income will be taxed at 40% in payment. In effect this is the same as a tax of 55% being applied. The following two silly numerical examples show why:
- 1,000 x 55% = 550 (leaving 450)
- 1,000 x 25% = 750.† 750 x 40% = 300.† 750 Ė 300 = 450.
It doesnít matter whether you get hit by 55% up front or 25% up front and 40% on the income the end resultís the same, itís just the timing thatís different. Itís as broad as itís long.
OK, thatís that one, and having re-read the BeeLine so far I think Iíve gone straight into heavy again, sorry about that. To lighten up a bit and get back to the fun stuff perhaps I should let you know that the Organisation of Economic Co-operation and Development (OECD) has recently said that the UKís state pension system provides just about the lowest pensions in the whole of the Western World *. Out of a survey of OECD countries weíve come out at 26th out of 30 when comparing the percentage of average post-tax salary we can expect to get as a pension from the State.
Someone in the UK earning £22,000 a year (about average pay **) will probably get less than 48% of their post-tax earnings as a State Pension. The average for all OECD countries is about 69%, but some do much better than that. In Italy, Spain, Hungary and Austria, for instance, people can expect to get over 75% of post-tax pay as a State Pension. Mind you, the people in Luxembourg wouldnít think much of that as theyíre used to getting something more like 110%. "Ich bin ein Luxembourger!" could well turn out to be the Bee retirement rallying cry I think.
Funnily enough, even though the UK State Pension is a bit on the mean side for people on average earnings and above itís pretty good for the low paid. Someone on half average earnings in the UK can expect to get a State Pension of nearly 79% of their post-tax pay. Thatís because our Basic State Pension, which has always been redistributive, is supplemented by the State Second Pension (S2P) which has recently become so too. That is good, I think, but it canít be a good thing to have such low levels of State support in a country where pension saving is so polarised between the haves and the have-nots.
Mind you itís not all bad news. The UK State pension system came right near the top of one of the OECDís categories. Yes, youíve guessed it Ė weíre among the World leaders in complexity! ***
On that note I think Iíll call it a day with this BeeLine, just in case I start to lose all my enthusiasm againÖ..
26 August 2005
* OECD Policy Brief March 2005, "Solving the Pensions Puzzle"
** Office for National Statistics Employment, Earnings and Productivity Division, "Patterns of Pay: Results of the Annual Survey of Hours and Earnings 1998-2004"
*** BBC News (news.bbc.co.uk), "UK pension Ďnear lowest in Westí", published 2 May 2005.
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