Budget changes to the pensions Lifetime Allowance

When Pensions Simplification legislation was introduced back in 2006, the intention was that the new rules, which had been many years in the making, would not need to be amended in the future.

After fifteen years of revisions and tinkering by successive governments, that was, with hindsight, wishful thinking.

One of the pieces of the legislation that was introduced at the time was the concept of a Lifetime Allowance – a level of pension value that could be built up within the tax favoured environment of the pension regulations. Anything more than this would face a tax penalty, which can be up to 55% of the value above the Allowance.

The Lifetime Allowance was initially set at £1.5 million, but it had already been announced that this figure would increase over the following four tax years to £1.8m with the expectation that announcements would then follow, as to further potential additional increases. If an individual accrued a figure higher than this then there may be tax penalties. We say “may” because there were some opportunities for individuals who were close to, or over, these figures to put in place protection to avoid or minimise any tax charges dependent upon their circumstances. The impression at the time was that the figure of £1,800,000 would probably be high enough for it not to be a big problem for most pension savers.

However, after just two tax years of the Lifetime Allowance being at the level of £1.8m, the government reduced it to £1,500,000 in the tax year 2012/13 and from that point the trend was to introduce further reductions at fairly regular intervals, reducing to £1.25m in 2014/15, and down to £1,000,000 in the tax year 2016/17, thus widening the potential to trap more people from a tax perspective – in particular some members of public sector “final salary” schemes, but also many members of “money purchase schemes” such as Self Invested Personal Pension Plans (SIPPs) and Small Self-Administered Schemes (SSAS).

Chancellor Financial Management Ltd typically deals with company owners and high net worth individuals, so this issue is something that our advisers are now having to deal with on a regular basis. Each time there was a change in the Lifetime Allowance, further opportunities to put in place protection against the next reduction were introduced but the final two that were introduced in 2016 are still potentially available today.      

One saving grace at the time of the final reduction, however, was that the Lifetime Allowance, at its much-reduced level was then going to increase by inflation in future years, giving pension savers some hope at least. For three years this arrangement remained in place, however in the 2021 Budget, the Chancellor of The Exchequer, Rishi Sunak, announced a freeze on the allowance until 2026 at its current level of £1,073,100 (which was the original £1,000,000 plus inflationary increases).

Traditionally, individuals would have to buy an annuity to secure their pension income in retirement, which is essentially a guaranteed income provided for life. However, annuity rates are currently poor partly because of interest rates, (which are at historically low levels) and partly because of increasing life expectancy. Today a 65-year-old could generate a taxable income of £53,113* from a pension fund of £1,073,000. This is based upon a single life annuity, with no pre-existing medical conditions, non-smoker, remaining level throughout life. Clearly, most of us would like some inflation proofing to our income and may need to provide for a surviving partner and including additional benefits such as this would clearly reduce the income received. Understandably, a method of taking retirement benefits known as Flexi Access Drawdown (FAD) has become an attractive alternative to an annuity following the introduction of the Pension Freedom legislation in 2015. Under FAD, whilst the amount that can be withdrawn is unlimited, it is generally accepted that a “safe” level of withdrawal, where there would be an expectation that the income and capital could be maintained throughout life is somewhere between 3% and 4% of the pension fund, resulting in an income of £32,000 per annum to £43,000 per annum as a guide (based on an assumed pension of £1,073,000), clearly FAD does not provide a guarantee.  These estimates are simply an initial guide, which must be kept under review. One thing is clear, anyone with even relatively high pension savings should consider taking financial advice with the aim of minimising, or at least being aware of any taxation consequences. This should also highlight whether they could meet their expected lifestyle requirements in retirement, purely by funding pension plans within the Lifetime Allowance. The earlier they begin to consider this, the better.

If you wish to discuss your options, then please don’t hesitate to contact either Grant Farnell or David Torkington.

A pension is a long-term investment. The value of an investment is not guaranteed, and you may get back less than you originally invested.