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

Many Trustees are missing the opportunity to reduce risk

Things are looking up for pension scheme funding – at least from an investment point of view. However many Trustees are failing to seize opportunities as they are presented, or simply believe that better times await.

Gilt yields have risen from their lows in 2012 and this has resulted in the present value of liabilities reducing. For a typical pension scheme, the impact of rising yields is expected to have reduced the present value of the liabilities of a typical scheme by approximately 10% to 15% since July 2012. Inflation pressures (at least in the short term) have eased with CPI falling below 2%.

Trustees should also have seen strong improvements in investment returns with the MSCI World Index providing 16.8% p.a. returns over the five years to 28 February 2014 – certainly ahead of the likely investment returns assumed in the average pension scheme’s funding assumptions.

What does this mean for Trustees and sponsors? For those that haven’t planned, it simply means that any deficit could be made good sooner, and employers may hope that any recovery plan payments will reduce or cease early.  The belief is that investment risk needs to be maintained if that hope is to be realised.

Trustees don’t need to go that far back to recall similar ‘feel good’ moments, such as the end of 2007 when many schemes were in a much healthier funding position before the financial crisis of 2008/2009 set in.

For any scheme that is closed to new entrants or accrual, or whose liability is having an impact on the balance sheet of the sponsor, simply doing nothing should not be an option.

There are three issues the Trustees should be considering:

·    Given the improvement in funding above where we thought we would be at this point in time, can we reduce the current level of return required (i.e. can we have less exposure to growth (or risk) assets without impacting on the schemes ongoing funding basis and recovery plan?

·    Where growth assets are still needed. Is it possible to deliver growth more efficiently, with less risk?

·    Given the rise in gilt yields and falling inflation expectations can we use this as an opportunity to reduce funding level volatility that arises from changes in interest rates and inflation?

Of course those Trustees who do not have a plan in place, answering these simple questions can take time. With Trustees typically meeting on a quarterly basis, there is the risk that opportunities would have evaporated by the time they are ready to act.

According to the Pensions Regulator’s ‘Occupational Pension Scheme Governance Survey’ (2013), 45% of pension schemes do not have a long term de-risking ‘flight plan’ in place.

BROADSTONE has a five step de-risking plan to help guide the trustees through the design and governance process to ensure that opportunities to de-risk are not missed.

Peter Dean

Investment Consulting Director

Telephone:  +44 (0)20 7893 3456

Email:  contactus[@]broadstoneltd.co.uk
 

 

Are auto enrolment contributions alone enough for retirement?

Following on from Rob’s last post on why we’re all being automatically enrolled, I thought it would be a good time to tackle whether these auto enrolment contributions alone are going to be enough for retirement?

In short, it’s unlikely.

Now the contributions are being phased in. Using the default earnings basis the contributions will start at 1% for the employee and a minimum 1% for the employer, from October 2017 this will rise to 3% for the employee and a minimum 2% for the employer, and finally from October 2018 it will be a 5% employee contribution with a minimum of 3% from the employer. So from October 2018 it will stabilise at a total of the equivalent of 8% of your salary being paid into your pension.

But what does that mean in terms of what you receive when you retire?

Well to put it into context, Scottish Widows 2013 UK Pensions Report says that “the average British worker anticipates stopping work around age 66 and is looking for retirement income of £25,000 a year. That would require savings of £1,000 a month from age 30.”

On an equivalent salary of £25,000 a year now, that would be a contribution of 48%. For many receiving only the minimum employer contribution of 3% at 2018, that means they will need to find a contribution of 45% from their own salary!

To be fair, many people are looking to live on around half their salary at retirement, but that still means on a salary of £50,000, you would need to contribute 21% of your salary from 30, receiving 3% from the employer.

Now you may not want to retire by 66, or need an annual pension of £25,000, you may need more, you may need less. The message is that you should take this as an opportunity to think where you’d like to be at retirement, and whether or not the auto enrolment contributions alone will ensure you have the kind of retirement you can look forward to.

Charles Goodman

Consultant

Telephone: +44 (0)20 7893 3972

Email:  contactus[@]broadstoneltd.co.uk