So, Budget 2015 brought us another change to the lifetime allowance (LTA), with the proposal to reduce it from £1.25 million to £1 million. This now seems to be the pension policy of choice for at least two of the main political parties.
The change will result in two new forms of protection and lots more confusion.
Now, I have always been of the view that we do not need an LTA when we have an annual allowance (AA).
It just confuses matters, creates extra administration and cost and, in reality, is just a tax on investment performance (the only saving grace is that a change to the LTA is easier to administer than a change to rates of tax relief).
When the LTA was introduced in 2006 there was much discussion about what it would mean and what it was worth in terms of pension.
In March 2004 there was an NAO Report on "The Government estimate of the impact of the pension lifetime allowance". One particular paragraph stood out:
"It is factually accurate that, assuming a 20:1 valuation factor, £1.4 million is broadly equivalent to the maximum pension allowable under the current occupational pensions regime, which includes the earnings cap. That does not mean that such a sum would at any given time necessarily be enough to buy such an income." [My emphasis]
When the LTA finally materialised it was at £1.5 million instead of £1.4 million, and the earnings cap was just a bit over £100,000. So the maximum pension referred to was broadly two thirds of the earnings cap – i.e. somewhere around £70k p.a.
Annuity rates at the time would have refined the appropriate level of pension that could be purchased and some DB schemes that did not require annuity purchase may have been able to offer a higher amount.
The LTA from April 2016 is proposed to be £1 million and, based on current annuity rates, this means an index-linked joint life pension for a 65-year-old male of something like £27,000 p.a. (around National Average Earnings).
So, since inception (and in spite of a period of incremental increases to £1.8million) the LTA will have fallen by some £500K and the pension from it will have more than halved for DC savers.
For DB savers the story is different, in that the LTA for DB schemes is calculated as 20 x the pension, so for a DB scheme the LTA equates to a maximum pension of £50,000 p.a.
In the Budget Report it was suggested that the change would affect fewer than 4% of savers approaching retirement, but this has already been questioned as something of an understatement!
One of the big problems could be with those in DB schemes who are close to the LTA but have never valued their entitlement – why would they? If they did know, would they opt out of the scheme?
One positive that came for the Budget was the announcement that the LTA would be indexed in line with CPI from 2018. (The subtle three year delay perhaps loses even more value?)
As I have said above, I have never been sure of the need for both the LTA and an AA, but if we have them, lets have the value linked to some sort of policy - perhaps to provide a prescribed level of pension?
Let's also have some 'big picture' thinking – in, say, 20 years' time, with the changing demographics forecasted, what is likely to be the effect of reducing incentives to save? Tax take and non-reliance on State versus bigger welfare bill?
Oh for some joined-up thinking and a long-term aim!
Mike Morrison
March 2015