Reduction in pension lifetime allowance – who will feel the impact?

25th February 2016

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With less than six weeks until the Chancellor introduces yet another attack on pension funding, with a further reduction in the lifetime allowance (LTA), Gary Smith, financial planner at Tilney Bestinvest, delves into the far reaching nature that these changes will have…

In the last Budget of the Coalition, in March 2015, George Osborne announced his third reduction in the pension LTA since 2012.

The measure, to be implement in April will see the allowance cut from £1.25m to £1m following which it will be adjusted for inflation each year from 2018.

We hope that this marks ‘ground zero’ as since Mr Osborne became Chancellor, the LTA has been reduced from £1.8m to the soon to be introduced limit of £1m, a savage reduction of almost 45% in less than five years.

Whilst it could be argued that the previous reductions to the LTA have only impacted quite wealthy individuals, this latest reduction will impact those hard working individuals who have been prudent in their savings towards retirement.

Indeed, it is not only those who have built up pension funds that are close to the £1m limit that need to be aware of this reduction as, due to future investment growth and pension funding, those who currently have much modest pension values today could be impacted.

To highlight this, the table below illustrates what fund value a 40-year old pension saver would currently require to exceed the £1m limit by their 65th birthday.

These projections assume that a 5% per annum growth rate is attained and that varying amounts of pension saving are made.

Additionally, the Chancellor also noted that from the tax year 2018/19 the LTA will be indexed annually in line with the Consumer Price Index. For the purpose of this exercise I have assumed that this will rise by 2% per annum from 2018/19 tax year onwards:

 

Current Fund Value Assumed Future Contributions
£465,000 £0
£422,000 £250 pm
£377,000 £500 pm
£289,000 £1,000 pm

 

So, a 40-year old who does not intend to make any future contributions would exceed the £1m limit if their pension fund value is at least £465,000 and 5% per annum investment returns are attained.

For those who are fortunate to be able to save £1,000 per month into pensions, they would exceed £1m if their fund value was currently £289,000.

What is clear is that this reduction in the LTA is likely to impact on significantly more individuals than the 55,000 that the Chancellor estimated would be affected, and many pension savers will potentially face a very nasty surprise when they reach retirement by incurring a LTA tax charge on any excess above the £1m limit.

The Chancellor would point out that new protections will be made available to those who could be affected but, as no further contributions could be made to secure Fixed Protection and, as Individual Protection is only available to those with pension funds that exceed £1m, these options are unlikely to offer any benefit to those individuals who are someway off their eventual retirement and who continue to save prudently.

It also now seems inevitable that further attacks on pension tax reliefs and funding will be announced in the Chancellor’s forthcoming Budget statement on 16 March 2016 and, these changes could reduce the capacity for hard working savers to build up worthwhile pension values to support their anticipated retirement lifestyles.

Indeed, the “squeeze” on pensions tax relief could be seen as a desperate act of a Chancellor in his attempt to secure a Budget surplus by the end of the current Parliament, whilst restricting his options to do so by promising not to increase Income Tax or National Insurance and ring-fencing some major departments from any spending cuts.

Is this really what the Chancellor had in mind when he announced his much welcomed introduction of pensions freedoms and rewarding those who had saved all of their lives towards retirement?

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