By Malcolm McLean OBE, Senior Consultant, Barnett Waddingham
Let’s not forget that when the LTA was first introduced, as part of the 2006 ‘A-Day’ changes to “simplify” pensions, the LTA stood at £1.5 million, rising to £1.8 million in 2010/2011. It was then progressively reduced in previous Budgets to £1 million in the 2016/2017 tax year. Had the original £1.5 million LTA been linked to the CPI, or even better the Retail Prices Index (RPI), from the start in 2006, it might have been close to double its value by now.
So where do we go from here?
I am very supportive of those many advisers who would like to see the LTA scrapped. In fact, I don’t really see why the Treasury is so resistant to this. Tax relief is given, as it were, on the way in and tax levied on the way out, which for high earners and big pots is likely to be at the highest rates. There would probably have to be a cap on the tax-free lump sum but nothing else. The rest would take care of itself.
Ending the LTA would bring with it much needed simplicity to a system which is time-consuming to administer and confusing for savers to get to grips with. It also often serves to work against those prudent enough to want to save for their retirement. It is also worth pointing out that there is great inconsistency of treatment between defined contribution (DC) and defined benefit (DB) savers at the present time.
For a DB saver, £1 million (the current level of the LTA) provides an annual pension of £50,000 on the basis of a formula which values the notional pot at 20 times the annual pension e.g. 20 x £50,000 = £1,000,000.
For a DC saver, an actual pot of £1 million would provide an equivalent pension (annuity) with inflation increases and spouses’ benefits of less than £30,000.
Bringing them more into line would be desirable but not be easy. One way would be to have a different (higher) LTA for DC of, say, £1.5 million to boost the pension payable - but it is not clear how that would work for someone who had savings in both types of pension when those collectively exceed £1 million but individually are within the limits.
The other way would be to keep the single limit but change the 20 times valuation formula for DB to perhaps 25, and thus reduce the amount of pension allowable, e.g. 25 x £40,000 = £1,000,000. The downside of this of course is that whilst the results are more equitable between the two types of pension, it is taking us the wrong way and could even be accused of encouraging a “race to the bottom”.
As for the bigger picture, I am sure for the vast majority of people the thought of having a million pound pension pot is nothing more than a pipe dream. But the reality is that the prospect of breaching the LTA is a growing problem for many in the professional classes, including doctors, dentists, head teachers, city workers and the like – particularly if they have started their pension saving at relatively young ages.
Index-linking the LTA is a start to improve the problem but is not the full answer. There could, however, be some further light at the end of the tunnel arising from an initiative that was mentioned briefly in the Budget. This would involve a relaxation of both annual and lifetime limits on pension savings to encourage investment in a “patient capital investment vehicle”, a government-backed investment fund directed at illiquid assets such as infrastructure or private equity. Investors could then be allowed to breach the existing limits on pension savings if they were to put money into such a fund, opening the door to continuing their saving without being hit with a substantial tax charge.
It will be interesting to see how this develops and how far, at the end of the day, the Treasury is prepared to loosen the reins and do what it really ought to be doing; encouraging pension saving, not putting obstacles in the way of honest people wanting to do so.
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