Budget 2015: The government has announced that it will reduce the pensions lifetime allowance (LTA) limit to £1 million from 6 April 2016.
It was also announced that from 2018, the limit will be index-linked and adjusted according to the level of inflation.
The current lifetime allowance has stood at £1.25 million since April 2014. It was previously £1.5 million before being cut by the government in the 2012 Autumn Statement.
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Chancellor George Osborne announced the plans in his 2015 Budget. He said the reduction would save £600 million.
However, he ruled out cuts to the annual allowance, which is currently set at £40,000.
He said: “Over 96% of individuals currently approaching retirement have a pension pot worth less than £1 million, so this change will affect only the wealthiest pension savers.”
Malcolm McLean, senior consultant at consultancy Barnett Waddingham, added: “Frankly this is unfair, unnecessary and unwise.
“Although a million pounds still appears to be, and is, a very large sum of money, which clearly is beyond the aspirations of the average pension saver, it does mean that for a defined contribution pension pot it actually only produces an annual pension of little more than £27,000 (inflation proofed and providing for a spouse).
“In many respects, the concept of having a lifetime limit is outdated and unnecessary, now that the annual allowance has been reduced to £40,000 and is the effective controlling mechanism for limiting tax relief on pension saving.
“The existence of the LTA and the regular monitoring against it overly complicates pension saving at a time when strenuous efforts are being made through automatic-enrolment and other measures to encourage saving into a private pension.
It is no surprise that the lifetime allowance has again been reduced. This has been on the Chancellor’s agenda for some time. And while George Osborne has predicted that only 5% of people approaching retirement will be impacted by the reduction, those who are effected could lose out substantially.
Osborne has also not specified how this will impact those in defined benefit schemes – it may be the government needs to offer express protection measures for those who have been in such schemes for some time.
Constantly lowering the LTA disincentives individuals to save for their retirement through a pension. It seems at odds with the encouragement to save being driven through the workplace with auto-enrolment as an increasing proportion of customers will approach the limit and have to make decisions about what action to take.
£1 million might sound a significant amount, but it only buys a circa £30,000 pension and is typically what many middle income earners are likely to achieve by the end of their career. While we welcome the decision to index the LTA from 2018, it should be noted that it is expected to be 15 years before the LTA gets back to £1.25 million, based on 2% CPI inflation.
We would like to see innovation in the alternative solutions that are offered, particularly for middle income earners, to continue incentivising individuals to save for retirement. For example, the answer may well be to put money into an ISA, with employers supporting their employees by offering a ‘corporate’ ISA with salary sacrifice and employer contributions.
With ever increasing life expectancies, another cut in the lifetime allowance will make it difficult for many members of defined contribution schemes, who would not consider themselves high earners, to save enough to maintain their living standards through to the end of their retirement.
The lifetime allowance has been slashed from £1.8 million to £1.25 million over the last three years. Today we’ve seen it cut further to £1m. The Chancellor says that it will affect fewer than 4% of those approaching retirement. We think 15-20% could be impacted by this ultimately.
This is a policy that could act as a disincentive to doctors, dentists and secondary school head teachers saving into pensions. We would expect mid-senior managers earning £90,000 plus to build up a pension pot of over £1m over their lifetime. £1m sounds like a lot of money, but it delivers an annual income of around £30,000 per annum in a DC scheme.
An interesting point to note is that while a £1m tax free pension pot will deliver a £30,000 DC pension it will give a DB pensioner an income of £50,000 in retirement. In that context, changing the annual allowance hits DC pension savers harder than DB. The reasons for this are historic. The terms at which a DB pension pot are converted into an income were set over a decade ago at 20:1. In contrast, DC pensioner’s pots are converted at the market rate which is closer to 30:1. As a consequence, this policy disproportionately penalises DC savers.
While indexing the annual allowance from 2018 will to some degree help prevent this policy impacting the masses, the CPI increases that will come into effect in 3 years won’t be enough to offset the number and scale of cuts we’ve seen in recent years.
The pace of change in pensions has been unrelenting. Pension saving is about taking a long-term view. A period of stability is needed to allow individuals to better plan for their retirement.
There will clearly be concerns that the Chancellor’s announcement to reduce the lifetime allowance will further make pension savings unattractive to medium to high earners, which may disenfranchise those senior individuals who make decisions for UK pensions for their employees.
Although the £40,000 Annual Allowance has been spared in this Budget, as rumoured, the Lifetime Allowance (LTA) has once again come under the Chancellor’s spotlight with a further reduction from £1.25 million to £1 million being announced. This is the third time in as many years that the LTA has been targeted, the impetus being to curb the size of very large pension pots and a saving to the Exchequer of around £600 million a year.
Transitional protection for pension savers with rights already over £1 million will be introduced alongside this latest reduction in the LTA.
In addition, perhaps in an attempt to soften the blow for the pension savers who will be hardest hit by this change, from 6 April 2018, the LTA will be indexed annually in line with CPI. Nonetheless, this is all a far cry from the heady heights of March 2012 when the LTA stood at £1.8 million.
The Chancellor’s commitment to index-link the Lifetime Allowance from 2018 is welcome. But the question remains, what will the LTA be in three years’ time?
Let’s hope past performance is not an indication of future cuts. The LTA has been cut by £0.5m in the last three Budgets which if repeated would leave an LTA of £0.5m. This would buy an income of around £10,000 per year.
Another cut to the Lifetime Allowance will bring increasing numbers of middle earners into paying punitive tax charges and added complexity into the system. A reversion to indexation of the LTA from 2018 is welcome but arguably the annual cap on contributions there is actually no need for an LTA at all.
The allowance reduction of £250,000 means a 40% tax payer will pay an extra £62,500 on that slice. The cost to a basic rate taxpayer in retirement will be £100,000.
The lifetime allowance will be reduced to £1m (from £1.25m) from April 2016, with plans to index it from 2018. If implemented as planned, it will create another raft of different protection issues for people close to or beyond the £1m mark, introducing further complexity to the system. In practice, almost all political parties are committed to a wider review of tax relief on pensions, so this may be superseded.
Reducing the lifetime allowance from £1.25m to £1m will have impact on a number of employees approaching retirement and particularly those in defined benefit schemes who may suddenly exceed the limit, perhaps due to a promotion and subsequent pay rise. A number of employees who are close to the limit may look at other savings vehicles such as ISAs as an alternative, especially given the announcement about the new fully flexible ISA. This new pension world is about looking at all savings and assets to provide retirement income and to ensure they are accessed in the most tax efficient way. It is important to utilise available tax allowances and reliefs in a structured manor and advice is crucial in this respect.
There is little doubt that this will increase demand, among a significant larger number of people planning for retirement, to invest in a broader range of tax-efficient pension supplements, including VCTs. We’ve already seen a substantial increase in investor interest in VCTs following earlier reductions in the pension lifetime allowance and expect this additional reduction to further boost demand.
In cash terms, the Lifetime Allowance has been reduced from £1.8 million in 2010 to £1 million in 2016. Once you take account of inflation, its real value will have more than halved. As with previous cuts to the Lifetime Allowance, people who already have pension pots worth more than £1 million will be protected – but for higher earners who haven’t already done their pension saving, it will be too late.
There is a stark inconsistency between the effects of the new Lifetime Allowance (LTA) of £1 million on defined benefit (DB) and defined contribution (DC) pensions.
In the DC world, £1 million may buy an increasing pension of only around £25,000pa, while in the DB world you are allowed a pension of £50,000pa without breaching the Lifetime Allowance (LTA). This is because HMRC uses a fixed factor of 20 to calculate the LTA for a DB member and you cannot currently buy £1pa of increasing pension for anything like as low as a £20 premium.
If this inconsistency is not resolved we could see the development of middle and senior managers wanting to join a DB scheme just to ‘bed & breakfast’ their pensions in order to get the higher tax allowance.
It’s also worth bearing in mind that the LTA now limits DC pensioners to an income which is probably below the national average earnings for full-time employees (£29,536pa).
If the Lifetime Allowance (LTA) is reduced to £1 million, this will mean that, based on current rules, any member of a DB scheme with a built-up pension of £50,000 on retirement will be hit by the penalty tax charge. It’s not just the highly-paid who will be hit – this will apply to many public sector workers who have built up their pensions through longevity in the workforce.
We’re also concerned that the Government may change the terms on how DB schemes are valued for LTA purposes. If they change the DB valuation factor to, say 25:1 then with a revised LTA of £1 million, any person with a DB pension worth more than £40,000 at retirement will be hit with a penalty tax charge. This, along with restricting tax relief on pension contributions for higher-rate taxpayers, will mean that many people will look to other forms of savings, such as buy-to-let housing, instead of pensions.
The reduction in the annual Lifetime Allowance (LTA) to £1 million will hit DC savers harder than DB members. Under current rules, a DB pension of £50,000 will be impacted by the penalty tax charge. In contrast, an equivalent DC saver will only be able to receive a much smaller annuity before they are affected by the penalty tax charge. We estimate that a DC member will typically be able to buy a pension of under £25,000 a year based on current annuity rates.
On the face of it, £1 million is a huge amount of money and beyond the reach of many. However, the impact of this reduction on DC savers reminds us that they continue to be the poorer relation when it comes to pension provision. To an extent, some DC savers will therefore welcome the Chancellor’s announcement of tax free savings on personal savings accounts of up to £1,000 a year and the increased ISA allowances as an alternative to pension savings.
There has recently been a call for an increase in the level of total contributions to a pension arrangement to 15% of salary. For a 25 year old saver currently on a £30,000 salary then, using standard illustrations this participant would accumulate pension savings of £1.1m over his working life, which is in excess of the LTA. This cannot be the Government’s objective.
One thing not normally mentioned in articles about lifetime allowances is the different amount of pensions the lifetime allowance will purchase between a defined contribution (DC)scheme and defined benefit.(DB)scheme
As stated in this article a person with a lifetime allowance of £1,000,00 in a DC scheme would receive a pension of roughly £27,000 where a person in a DB scheme will be allowed a pension of £50,000, almost double.
The reason this happens is that DB schemes use a factor of 20 to 1 no matter what there age is when they retire..
So as you can see people in DB schemes are treated more favourably than people in DC schemes regarding the amount of pension they can receive using the life time allowance.
If the two different types of schemes were to be treated the same the conversion factor for DB schemes would have to be roughly 37 to 1 which won’t happen as most DB scheme members are in public service schemes.
To purchase a pension of £50,000 for a DB scheme using current rares would cost about 1.8 million pounds.
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