Pensions’ lifetime allowance – another kick to responsible savers

What do Chancellors of the Exchequer and mousetraps have in common? They both trick the innocent mouse! I struggle to understand what it is about pensions that allow Chancellors of all political persuasions to treat responsible pension savers with such disdain.

I don’t expect many members of the public to have much sympathy with a rant against the freezing of the pensions’ lifetime allowance (LTA). Taxpayers’ money is not available for a permanent increase to Universal Credit. Nurses, who have worked so hard during Covid-19, are being offered only a 1% pay increase (although this is against a backdrop of a public sector pay freeze). Any whinge therefore from those with a pension pot in excess of £1m can’t expect a warm audience. However, taxation should not be about soundbites and emotion. Taxation should be rooted in sound economics and changing behaviours to good outcomes for society.

Pensions exist to give us an income in our retirement years. We choose to save into pensions during our working life according to the rules at the time in the reasonable expectation of what these pension contributions will give us perhaps half a century later. We accept that once paid in, we can’t take the pension contributions out until retirement. With the demise of the final salary pension scheme, we are increasingly paying into defined contribution pensions. These require the individual to take on the risk of the ups and down of the stock market as there is no funder guaranteeing the pension quantum paid to us in retirement. The hope remains though that over the very long term the stock market will rise. We believe that our pension will be sufficient, given the amount we have set aside and the careful assumptions we have made acting on competent advice by qualified professionals.

The defined contribution pension saver has much more risk to take on than those who are in defined benefit schemes. Governments should therefore be encouraging us to fund our defined contribution pensions well (eg our SIPP). The taxation framework is a critical and fundamental component to our pensions. Tax legislation gives us tax relief at our marginal rate of taxation on our contributions. We pay tax when we draw our pension at our marginal rate after our 25% tax free income from our pension.

Many of us aware of the humorous three hours exam paper that starts “Read the entire question paper carefully to the very end before beginning to answer any questions”. The paper has 20 detailed questions and at the end of the questions is written “Ignore all the questions above. Write your name on the answer sheet, hand it in to the invigilator, leave the hall and enjoy the afternoon.” It feels like those saving responsibly into a pension are being tricked.

The pension lifetime allowance (LTA) was introduced as part of so-called ‘pension simplification’ back on A-Day in April 2006 by Tony Blair’s Labour Government. The allowance is currently set at £1,0731,000 in the 2020/21 tax year, although it has altered numerous times since it was initially introduced at £1.5 million in 2006. The LTA reached a peak of £1.8 million in 2011 and steadily reduced up until 2016/17. The downward trend was to be reversed and the LTA was to increase each year in line with CPI inflation but now thanks to the Budget even this modest annual increase will not happen.

All these changes mean that we cannot have confidence when we enter into a very long term pension arrangement (for up to fifty years or even longer) that the rules won’t change. Governments borrow money in the markets on the basis that they can be trusted to pay the money back. The less the trust in a government, the more the market will want in interest to lend governments money. If taxpayers cannot trust their government to stick by long-term pension rules, then that government will lose trust and pensions will be less popular at the very time governments need us to increase our trust in our own pension and thus reduce our reliance on the State Pension. This is why Rishi’s LTA change should not be passed into law. As it is, to cap the LTA annual increases at CPI is not right since the whole point of pensions is for them to benefit from stock market growth and compound interest. At the very least the LTA must increase by earnings.

We already have annual limits on the amount that can be saved each year by way of pension contributions. There is also a real disparity between how those with defined contribution compare to those with defined benefit contributions as far as the lifetime allowance calculations are carried out.

If the Government wants more tax and yes, we need to pay back the £339bn* of additional debt the Government has taken on in debt in 2020/21 during the pandemic (over and above the pre-Covid-19 anticipated debt for 2020/21 of £55bn), then the well-off may need to pay more tax. However that increase may need to be from increasing the tax rates for everyone if necessary. To slip in a stealth tax for a few that breaks rules that we need to trust and rely on for 50 years and more and think no one will notice is not the right approach.

Rishi, we need to trust you and this change erodes trust and that governments do that at their peril. The Treasury’s Budget paper on the LTA change says that it will affect only 5% of the taxpayers. That means it is not a politically sensitive decision – lack of political sensitivity does not of itself make a policy right. Such logic would say that if only 5% of innocent people are sent to prison then it doesn’t matter.

Large numbers of those saving into pensions will be hit with a swingeing additional tax charge of 25% over and above their marginal rate of tax. Under OBR forecasting, the LTA would have been £89,200 higher by 2026 than it will be now. Taking this as a lump sum will be taxed at 55% creating an additional tax bill of £49,000. Paul Johnson (from the institute of Fiscal Studies) said it is an “absurd” to move the pension goalposts again. “How are savers supposed to make long-term plans for retirement in such circumstances is beyond me” he said.

A LTA of £1m might seem a huge sum but it actually only gets you a pension of c.£25,000 pa (with a 50% spouse pension and 3% escalation) if buying an annuity – hardly an excessively high pension.

Constant changes to the pensions regime only serve to add to the uncertainty so many people feel around saving into a pension. Rather than constant alterations, we need consistency so that people have confidence to save for the long-term. If governments must make changes to pensions they should be flagged up years in advance to give people opportunity to make different decisions in the light of different rules. In this case the LTA rules could be changed perhaps for those who are currently under, say, 45. As it is, the responsible pension saver could be forgiven for feeling like the mouse attracted to the bait of cheese only to be trapped the moment the poor mouse wants a bite of it!

David Eaton

*Source – Institute for Government.

This article is a general response to the Budget statement. It is not financial advice. Advice from a qualified IFA should be sought before making any investment or pension decision.