A big surprise in the Spring Budget was the abolition of the lifetime allowance (LTA). From 6 April, the tax charge for breaching it will be removed and the allowance itself will be scrapped from April 2024. This is “the biggest u-turn on pension tax policy in a decade”, says Jon Greer, head of retirement policy at Quilter.
Generally speaking, the abolition of the LTA is good news as it will allow you to contribute significant amounts to your pension without worrying about a tax charge. At its current level of £1,073,100, the LTA had become increasingly easy for middle earners to trigger. For example, the maximum income someone in a final-salary scheme could build up without paying a lifetime allowance charge was £53,655.
People whose pensions were above the value of the LTA and due to be tested against it in the near future stand to benefit significantly. Tom Selby, head of retirement policy at AJ Bell (AJB), says that an example might be a retiree approaching their 75th birthday who crystallised their entire £1mn pension pot in the 2016-17 tax year, took £250,000 tax-free cash and put the remaining £750,000 into drawdown. The retiree has not touched the drawdown fund since and kept it invested with a pretty aggressive strategy, resulting in 10 per cent growth a year. So by the time they are age 75 and the pension is tested against the LTA, its value has grown to around £1,461,000. Before the changes announced to the LTA, this would have resulted in a 25 per cent or £96,975 charge, with income tax to pay on top of that.
People who had stopped contributing to their pensions for fear of breaching the LTA can consider restarting. Jason Hollands, managing director of Bestinvest, says that a retirement saver could potentially subscribe up to £180,000 to pensions next tax year by using the new larger £60,000 gross annual allowance plus unused allowances of £40,000 for each of the previous three years under pensions carry forward rules.
Dean Butler, managing director at Standard Life, adds that the abolition of the LTA will “super charge the attractiveness of defined contribution pensions as a means of passing on wealth”. Pensions were already a tax-efficient way to do this because they do not form part of your estate for inheritance tax purposes, but the LTA limited the amount.
However, Alice Guy, head of pensions and savings at interactive investor, argues that the changes will leave “a sour taste in the mouth” for those who’ve retired recently under the old rules and paid a tax charge. And Greer “wonders how long such generosity will last as we’d expect a significant uptick in the amount being funded into pensions by those with higher earnings”.
Gary Smith, partner in financial planning at Evelyn Partners, adds that the uncertainty on how the removal of the LTA will play out is “exacerbated by Labour’s pledge to reinstate the LTA if it gains power after the next general election. What level will the LTA be at then? Will people who have contributed more in the following tax year and the one after find themselves penalised for then being on the wrong side of the LTA?”
The maximum pensions tax-free lump sum that you will be able to take has been capped at £268,275, 25 per cent of the current lifetime allowance. Guy notes that its real-term value will decrease over time, and “this change may turn out to be a huge disincentive to some pension savers and may erode one of the simplest and best-loved pension rules”.
On the plus side, HM Revenue & Customs has confirmed that for the next tax year those who had taken out fixed protection to preserve access to earlier LTAs of £1.25mn or £1.5mn can restart their contributions without renouncing their bigger tax-free lump sums. Hopefully, this will be permanently confirmed for 2024 onwards when the LTA is abolished.
