The Lifetime Allowance: How Low is Too Low?

In March, the Lifetime Allowance (LTA) was cut once again by Chancellor George Osbourne. He has also claimed that by 2018 the LTA will be indexed-linked, adjusting with inflation.[1] The amount of tax-free savings an individual can have in their pension fund upon retirement has been reduced from £1.25 million, for the tax year 2015/16, to £1 million, for the year 2016/17.[2] Any pension savings exceeding the £1 million LTA will be taxed at a rate of 55% on anything taken as a lump sum and at 25% if the excess is taken as an income (such as a scheme pension or annuity).[3]

Given the pressure that Osborne is under to reduce the deficit, it is perhaps reasonable that he would choose to cut the LTA; after all, the cut will save the Treasury around £600 million a year.[4] And there is good reason for the existence of LTA. The Government uses the promise of tax-free pension savings to incentivise the UK to save money for retirement – once no longer earning, they will not be dependent on the state. And, arguably, there can be little point in offering tax relief to pensioners beyond the level required for fairly basic living. This would be a luxury the state cannot afford; more relief simply means greater deficit.

When commenting on the recent cut, Osborne said that the limit for the LTA is so high that, “Fewer than 4% of pension savers currently approaching retirement will be affected”.[5] However, whilst that maybe true for soon-to-be pensioners, the rest of the UK may be less fortunate. As the Pension Advisory Service rightly points out, pensions are a long-term commitment and what may seem a modest accumulation of savings to start with may exceed the LTA by the time benefits are drawn.[6] Furthermore, the LTA applies to total pension savings - anyone who has had more than one job, and consequently more than one pension scheme, should keep this in mind.

The LTA cut will disproportionately affect those with a defined contribution (DC) pension scheme compared to those with a defined benefit (DB) scheme. Typically, those working in the public sector will have a DB scheme; this type of scheme is far easier to monitor, meaning you can stop contributing to or draw from your pension scheme before you hit the LTA limit. However, if you work in the private sector, you are likely to have a DC scheme. Should the investments made by your pension provider be successful and you pension exceeds £1 million, you could be penalised with a 55% tax rate. Although one can monitor how much is contributed to a DC scheme, it is impossible to know how much that pension will ultimately be worth. Thus, the investor pays the cost of poorly performing investments but risks just as much with investments that are successful. £1 million may seem like a vast amount of money but is reasonably easy to achieve. So, the LTA may affect a far higher percentage of the population than just the very richest amongst us.

It is possible that even the most modest savers could hit the LTA if their investments perform well over their lifetime. Consequently many savers will be discouraged from saving, which would risk them being dependant on the state for part or all of their retirement (the problem being further compounded by an ageing population). The £1 million LTA seems low, particularly since the annual allowance is already in place to limit tax relief on pensions. Achieving the right balance between an LTA that helps to reduce the deficit by taxing only those with the largest pension funds, and one that is so low it discourages people from contributing to pension funds altogether, is a challenge. Hopefully, if the LTA is indeed indexed in 2018, this will protect pension savers from an ever decreasing LTA (the new LTA is just 66% of the £1.8m LTA for 2011/12).[7] But in the meantime, everyone, however close to retirement, should keep a close eye on their pension fund.

Mark Howlett
CEO

Telephone: +44 (0)20 7893 3456

Email: contactus [@] broadstone.co.uk

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[1] Pensions Advisory Service, Lifetime Allowance Spotlight April 2015.

[2] Pensions Advisory Service, Lifetime Allowance Spotlight April 2015.

[3] Pensions Advisory Service, Lifetime Allowance Spotlight April 2015.

[4] http://www.theactuary.com/news/2015/03/lifetime-allowance-reduced-to-1million-says-chancellor/

[5] http://www.theactuary.com/news/2015/03/lifetime-allowance-reduced-to-1million-says-chancellor/

[6] Pensions Advisory Service.

[7] http://www.telegraph.co.uk/finance/personalfinance/pensions/11543227/The-death-of-pensions-has-it-begun.html