OUT of the mouths of babes and financial planners. The latest tax change by the British government was described by Henry Denne, head of private clients at Punter Southall Financial Management, thus

This very positive change transforms drawdown pensions from being “personal” pensions into family assets that can be very effectively used for inter-generational financial planning.

Inter-generational financial planning is the key phrase. The £150m spent on this tax change can only be described as a shameless handout to the wealthy at a time of austerity. The announcement came the day before the government announced a post-election freeze on benefit payments that will save £3 billion a year. It is almost as if the Conservatives are trying to live up to the way they are caricatured by the Guardian.

To put the change in context, one needs to explain the British system. Final salary pension schemes, where workers get a guaranteed income from their employers (which is taxed on receipt) are dying out. More and more people have so-called defined contribution (DC) pensions where they build up a pot. These contributions can be offset against tax, making them very attractive for those on the 40% and 45% top rates; returns on pension funds then accumulate free of tax; and a tax-free lump sum of 25% can be taken at the end. The cost of these various reliefs was estimated by the Pensions Policy Institute at £24 billion in the 2010-11 tax year (it must be higher by now).

The rationale for all these tax breaks is to encourage people to save for their old age, so they are less dependent on the state (in practice, almost everyone gets a basic state pension but many people rely on additional, means-tested benefits). Traditionally, the quid pro quo for all this was that retirees were forced to convert their pension pot into an annuity (an income for life, taxed at their marginal rate) or some kind of drawdown plan (a more flexible issue of the same idea). This requirement was abolished in the last Budget; the retired can do what they like with their money. If they draw it down, they will pay tax at the marginal rate. But if they leave the money untouched, no tax will be paid. It used to be that any unspent pension pots were subject to a 55% tax charge when transferred to heirs; this is now being abolished. From the government release

If the individual dies before they reach the age of 75, they will be able to give their remaining defined contribution pension to anyone as a lump sum completely tax free, if it is in a drawdown account or uncrystallised.

What justification is there for giving tax relief to people so they can pass pension assets on to their heirs? Ignore the guff about this being entirely people's "own money"; the largest proportion will come from employer DC payments and from tax relief. The government's announcement mentions that 320,000 people retire with DC pension pots and could potentially benefit; what it doesn't mention is that most people have very small pots that they are likely to run through before death. The average pension pot at retirement is just £25,000, according to the Pensions Regulator. Andy James, head of retirement planning at Towry, commented in the FT that

Sadly, the changes to the tax charges on death for pensions will not help those who are still struggling to build up sufficient funds to pay for their retirement

Indeed, the whole system is skewed towards the wealthy; the PPI says that 70% of all the pension tax benefits accrue to the top two bands of taxpayers. While a skew is inevitable (the rich have more money to save, after all), there does not seem any crying need to increase their tax advantages.

To be fair, the govermnment has a £40,000 cap on annual contributions and a £1.25m lifetime cap on pension funds. But that still represnts a big tax shelter. Financial advisers like Hargreaves Lansdown are rubbing their hands with glee at the potential for business from the new tax regime. Tom McPhail of HL writes that

This is likely to encourage investors to take the maximum possible advantage of their pension contribution allowances

If the government really wants to benefit the majority of DC savers, it should do more to focus on the very poor returns that they receive after all the charges are imposed. A new report from Better Finance for All shows that savers across from Europe have often received negative real returns this century, with the estimate for Britain at -0.7%. The abolition of the requirement to annuitise, greeted by many newspapers as a great leap towards freedom, will probably end up luring many more retirees into buying such high-charging products post-retirement. Annuites offer low returns because interest rates are low (deliberate government policy) and because people are living longer. There is no magic formula for beating annuity rates without taking risk, and many people may take the wrong decision. The most likely to do so are the poor, who will not have access to the same quality advice as the better-off. Yet another way in which government policy has favoured the rich.