Cut pension taxes to solve the care crisis, Government urged

Older people should not be taxed when using their pension to pay for care costs, as retirees face losing almost half of withdrawals to government levies.

Pensions have become an unattractive route to pay for care, as large withdrawals can be taxed at rates as high as 45pc, a report from the Association of British Insurers trade body found.

Under current rules, people have to pay the full cost of their care until the value of their assets – including any property – falls to £23,250. It means that thousands of people who have worked their entire lives to own a home face losing almost all its value.

The Government said in 2021 it would expand the means-tested support and increase the lifetime cap to £86,000 this year, but this has been pushed back until after the next general election.

The delay is a window for the Government to reform the system so it is easier for older people to fund their care using a pension, the ABI said.

Savers can take 25pc of their pension tax-free at retirement, with drawdown withdrawals taxed as income. But for vulnerable people who want to take a bigger lump sum to put towards their care, they face being charged much higher rates of tax than normal.

The ABI urged the Government to either scrap or limit tax on pension withdrawals taken to meet care needs, including the purchase of an “immediate need” annuity.

The industry body also said that insurance pay-outs should be excluded from means-testing calculations, as it estimated that two-thirds of people will subsequently receive reduced financial support from their local authority.

For example, take a vulnerable person in residential care with a weekly income of £200, and £15,000 in savings. Under the planned reforms, the local authority would pay £508 a week towards their care.

However, this person took out an insurance policy against care needs and receives an additional £200 a week from the policy. Under the planned reforms, the local authority would reduce its support to £308 per week, meaning they are no better off financially.

Yvonne Braun, of the ABI, said that Government plans could “go a long way to help more people” cover their care costs.

She said: “Many people will want care services above and beyond what can be provided by their local authority. Insurance or pension pay-outs could help people afford top-up payments for additional services. However, as it stands, most people would actually lose out if they were to buy an insurance or long-term savings product to prepare in advance.”

A spokesman for the Treasury said: “We prioritised social care in the Autumn Statement, making up to £7.5bn over the next two years available to support adult social care and discharge – the biggest funding increase in history.

“For the majority of savers, pension contributions are tax-free so withdrawals are subject to income tax at an individual’s marginal rate, to reflect the fact that these funds have not been previously taxed.”

Reader Service: Do you know what makes a good pension pot? Learn how to find your old pensions to boost your savings.

Have you been hit by rising care costs? We’d like to hear from you, please contact lauren.almeida@telegraph.co.uk