Tax on pension withdrawals should be limited or scrapped altogether if funds are being used for later-life care, new proposals from the insurance industry have suggested.
A report published by the Association of British Insurers (ABI), in association with the Pensions Policy Institute (PPI), found that pensions are a growing source of wealth but pension allowance rules pose a limit to building up adequate pensions, especially if they need to cover care costs. The ABI also warned that current taxation rules for pension withdrawals can make them an unattractive option for later-life funding.
In its report, the ABI said: “The current taxation rules for pension withdrawals can make pensions an unattractive route to pay for care, especially if larger withdrawals are made, which can be taxed at 40% or even 45%. People are only likely to leave money in a pension to pay for care if the tax treatment on death remains as it is, and this should be taken into account in any wider pension tax changes.”
The ABI said the sale of immediate needs annuities, which cover the cost of care in exchange for a lump sum, could also be made more accessible if pension withdrawals were more tax efficient.
The cost of care has risen substantially in recent years, prompting growing calls for an overhaul. In September 2021, former Prime Minister Boris Johnson unveiled a plan for health and social care in England, which would introduce a lifetime cap on personal care costs of £86,000 and increase the thresholds of means-tested support provided by Local Authorities. While the proposals were originally expected to be introduced in 2023, Chancellor Jeremy Hunt announced in November the decision to defer the funding system until October 2025.
Tom Selby, head of retirement policy at AJ Bell said: said: “This constant kicking of the can down the road is a nightmare for those looking for certainty over how much their care might cost. It also risks putting off financial services firms who might offer long-term care products.
“However, one potential silver lining is it provides a window of opportunity to consider whether there are features of the existing system that could be improved ahead of the delayed introduction of the cost cap.”
Selby said that for millions of people, and particularly younger generations saving for the future, defined contribution pensions will be the “bedrock” of their later life spending plans and it makes sense for pensions and care funding to be linked.
Selby explained: “If people could access their pensions at a preferential tax rate – or even tax-free – to pay for care, this could have the dual benefit of incentivising higher levels of retirement saving and making it easier for people to pay for their own care if they need it. This should also reduce the likelihood of people needing means-tested support from the state.”
A further suggestion put forward by the ABI was the exclusion of insurance product payouts from the Government means-tested assessments for care.
The ABI said: “Paying for care in later life will always require a combination of public and private funding. This is because some people want to pay for services above and beyond what is provided by the state, and not everyone will be able to pay for their own care. The insurance and long-term savings industry has an important role to play in the future of funding social care in later life. However, there are a number of barriers to expanding a private market for products and services to help people pay for care.
“This is because two out of three people would have their means-tested support reduced automatically, if they received payment(s) from any care financial product. To address this, and to encourage the development of new products, we recommend that the payments from insurance products should be excluded from local authorities’ financial assessments – a policy which we estimate to be fiscally neutral.”
The ABI said its initial analysis suggests that excluding such payouts from the means-test is likely to have little or no impact on Government expenditure.
It said: “Disregarding payouts from the means-test would remove the disincentive for people to take out products, and for product providers to offer them. The fiscal outcome is the same and the customer outcome is improved.”
The ABI also floated the idea of family care insurance, suggesting that product ideas such as care gap or top-up insurance, income protection for carers and family insurance could allow adult children to cover some of the potential care costs of their parents or make it easier for them to temporarily care for their parents.
The industry body said it was important to note that there are other factors that hold people back from preparing for future social care costs, including an underestimation of the costs of care and the assumption that it is freely provided in the same way as NHS healthcare, as well as a lack of awareness around the fact they have an insurable risk. It called upon the Government to make the planned rules easy for people to understand and support people to plan in advance.
Selby said once there is greater clarity over how the new proposed system will work, people will need as much help and support as possible to understand the rules and enable them to make sensible decisions.
He added: “Ensuring the boundary between advice and guidance doesn’t act as a barrier to the provision of useful information to people in this, and other areas of financial services, is therefore of paramount importance.”
