HM Treasury should scrap or limit tax on pension withdrawals if the funds are to be used for care related purposes - including if they are to be used for an immediate needs annuity (INA) - the UK's Association of British Insurers (ABI) says. 

In its Prepare for Care report - published yesterday (9 February) - the trade body argued the current taxation rules for pensions withdrawals, particularly for larger withdrawals which can be taxed at a rate between 40 to 45%, makes it considerably more difficult for savers to consider using their pensions as an option to pay for their care.

The report - published alongside a technical report on care funding by the Pensions Policy Institute - found pensions could provide assistance to people to give them the care they need in later life, prolong their independence and delay any prospective transition to residential care.

It added, however, that savers would only be likely to leave money in a pension to pay for care providing the tax treatment on death remains unchanged - something it said should be taken into consideration in any prospective changes to the pensions tax system.

The ABI argued if the tax on pension withdrawals was to be limited or scrapped, it could make it possible for savers to purchase products such as an INA with pension funds and ensure any payments to the care provider could be taxed as income at the saver's marginal rate or could potentially avoid being taxed altogether. It also argueed reforms to the tax-efficiency of pension withdrawals could increase the accessibility of INAs.

Writing in the report's executive summary, the ABI said: "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.

"For instance, people are often unaware of the costs that they would face and what the state provides to meet their needs. They also tend to be reluctant to think of themselves as needing care in the future and to prepare for it in advance. None of the barriers are insurmountable, but they are significant.

"The government needs to make the planned rules easy for people to understand and support people to plan in advance and must also raise awareness of the need to prepare for the costs in later life and support people in navigating the system. The Money and Pensions Service should have a key role in delivering the right guidance to people at the right time to people considering their care costs, and signposting them to relevant solutions and appropriate advisers."

Generation X

The PPI report said defined contribution (DC) pension wealth could be a source of wealth to pay for care for some people but noted that for many people currently their pension may have been used to purchase a guaranteed income products and is not therefore available.

It added, however that generation X would reach retirement with more DC savings on average and there could be a higher prevalence of private pension saving as a result of auto-enrolment - adding the higher likelihood of having DC pensions may mean they have more easily accessible funds, that they could use to top-up for care of their choice.

Commenting on the ABI's report, AJ Bell head of retirement policy Tom Selby said: "For millions of people, and particularly younger generations saving for the future, DC pensions are going to be the bedrock of their later life spending plans. It therefore makes sense to explore linking pensions and care funding.

"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 incentive 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 needed means-tested support from the state."

The ABI's report follows a report published last year by the Institute for Fiscal Studies which called for the overhaul of the tax treatment of pensions pots after death to improve the fairness of the tax system.