Changes to the Lifetime allowance for Pensions

Thu 19 Mar 2015

In the 2015 budget, George Osborne announced a significant reduction in the lifetime allowance for pensions from £1.25 million to £1 million.

The lifetime allowance is effectively the upper limit on the value of an individuals total pensions (investment values and rights to income) that an individual may reach before suffering additional tax charges when coming to draw benefits.

The Chancellor made this significant change in a budget that cited the unsustainably high costs of tax relief as the chief reason behind the reduction.

Approximately two thirds of all current income tax relief (£30.4Billion in 2013/14) goes to higher and additional rate tax payers. The new changes reflect the perceived need to impose limits on the cost of tax incentives for those who might be said to have already established significant pension savings.

The change is due to come into effect on the 06 April 2016 and a new transitional protection option will be introduced to allow savers already above the reduced £1 million LTA to ‘lock in’ a higher allowance, although no details are available as yet.

This change follows a series of reductions down from a previous peak of £1.8 million in 2011 and will mean that many more individuals find themselves at risk of punitive tax charges when they come to retire.

The Chancellor did explain that the overwhelming majority of individuals currently approaching retirement (96%) have less than £1milliion and would therefore be unaffected however that will be of little consolation to the estimated 4% of the population who are already over the threshold.

Interestingly, the Chancellor refused to make changes to the annual allowance (the maximum tax relieved contribution that can be made in a year) on the basis that this would adversely impact many public sector workers accruing rights in their defined benefit pensions. However those very same workers will, of course, still find their overall pension entitlements assessed against the lower lifetime allowance when they come to draw their pensions.

Despite the reduction being bad news for a number of pension savers, the Chancellor did announce that the lifetime allowance will increase in the future. From 06 April 2018, the allowance will rise in line with the consumer prices index and will provide a welcome measure of predictability to future increases (although the allowance will effectively remain static in real terms).

The reduction in the lifetime allowance was not entirely unexpected as there have been calls for reforms in the way that tax relief is provided for a number of years. However, coming as it does in the wake of a recent record peak in the UK stock market, clearly there remains cause for concern for defined contribution scheme members, edging toward the new lower limit.

A fair wind and calm seas might just see a few more pension savers inadvertently nudged into the ‘unlucky’ 4% and with interest rates at historic lows, corporation tax reductions and brighter economic forecasts from the Office of Budget Responsibility, we may well have ideal conditions for sustained investment growth that would see them exceed the lifetime allowance.

Fortunately, it is not all bad news, the tax charges for exceeding the Lifetime allowance only apply on the excess, meaning that it is still better to benefit from investment growth even net of the additional tax that they will suffer at retirement. But if the lifetime allowance charges effectively nullify the benefit of any income tax relief received, serious consideration should be given to the level of continuing contributions being made.

With significantly increased NISA limits and plans to broaden the range of eligible NISA investments, the choice between a pension contribution (that may well suffer a lifetime allowance charge) and a NISA investment is no longer as obvious as it may once have seemed.

Investment forecasting, cash flow modelling and tax planning are all essential aids in navigating the choppy waters of pension reforms and perhaps now, more than ever, clients planning for retirement should seek advice.

Author: Philip Day