This week’s Budget announcements were a mixed bag for pension savers with a cap on the lifetime allowance creating inherent tax risks. Kay Ingram, director of public policy at LEBC, explains
On the one hand an anticipated reduction in the rate of tax relief granted on pension savings for higher and top rate taxpayers did not materialise. Neither did Treasury proposals to make all defined contribution pensions be paid via the relief at source method surface. It was this Treasury proposal published in July, as a means of giving low paid non taxpayers relief, which prompted fears that the rate of relief would be standardised to a flat rate for all taxpayers.
However, the freezing of the lifetime allowance at its current £1,073,100 was less welcome and means that younger, better off pension savers, are unlikely to be able to build up as much pension as their older colleagues who may benefit from one of the many lifetime allowance protection regimes.
The lifetime allowance (the cumulative amount which can be drawn from private pensions or passed on at death) has already been cut several times since 2012, when it stood at £1.8m. It now buys only £29,000 per annum of guaranteed pension for a defined contribution pension scheme member and just under £54,000 per annum for those in a defined benefit scheme.
Defined benefit scheme members are likely to reach this threshold sooner and so may choose to retire earlier, rather than accrue additional pension rights which carry an extra tax charge. NHS consultants have already left the NHS early in response to the effect of the shrinking allowance on the taxation of their pensions.
For defined contribution members there is less certainty as to the level of pension this frozen allowance will buy. The cost of a guaranteed income, secured with their pension pot, sees lower gilt yields and increasing longevity make each pound of guaranteed pension bought cost more.
By 2026, assuming inflation returns to its targeted 2% a year, the allowance will have shrunk to £971,901 in real terms. Many may choose to take advantage of flexible drawdown but then face the problem of achieving growth on their funds to match inflation and ensure their fund lasts as long as they do.
Included in the Treasury announcements was a proposal to allow pension schemes to take more risk with their investments and to fund the post Covid bounce back with investment in start-ups, green energy, and digital businesses. While it was great to see one half of the Treasury acknowledge the role pension schemes play in funding business, I wish they had spoken to their colleagues in the other half of the Treasury who had just cut savers’ tax exempt allowances.
It is doubtful that defined contribution pension savers will be keen to risk their retirement income on a high risk investment which if successful could result in them breaching the lifetime allowance and earning a 55% tax surcharge, whereas if it fails they will bear 100% of the loss.
Few advisers would be willing to suggest such a strategy when those savers with the appetite for higher risk can seek more generous tax treatment by investing in a venture capital trust (VCT) or enterprise investment scheme (EIS) arrangement.
This contradictory messaging from the Treasury is unhelpful and further proof that civil servants and politicians, who enjoy generous pension provision themselves, have little understanding of the issues facing voters seeking to save for their future.