The recent budget announced the abolition of the Lifetime Allowance, which taxes those who have pension savings over £1 million (£1,073,100 to be exact). Until 5th April 2023, unless protection was applied for, the difference between the total in the pension, and the Lifetime Allowance limit, was taxed at up to 55%.
On the face of it, this is a welcome change, which enables my clients with large pension savings to reduce their taxes, by a significant amount. This should make my clients happy, and therefore it should make me happy. Yes? Sadly, it’s not so simple.
The problem is that we don’t have certainty about the change. Immediately the abolition was announced, the Labour party announced that they would repeal it as soon as they were in government. Being realistic, that might well be in January 2025.
But even before then, it’s possible that the policy could be reversed by this government. The cost of the policy over the next 5 years is £2.75 billion[1]. To give some sort of context to this number, it’s 1.7% of the annual NHS budget, or 43% of the annual cost of tax credits[2]. However you look at it, it’s a material part of the UK financial balancing act. Is it the best use of the government’s limited fiscal flexibility?
All other tax allowances apart from this one continued to be frozen in the budget: the personal allowance for income tax, the nil-rate band for Inheritance Tax, the National Insurance thresholds. The allowances for capital gains tax and dividend tax went down. The only group of tax-payers who got relief were those with pensions valued at over £1 million. This doesn’t seem to be politically sustainable.
The Lifetime Allowance was removed not because the government thought that those with large pension savings, as a group, needed more tax relief than the rest of the population, but because it was a quick, “easy” way of solving the problems caused by the level of contributions to doctors’ (and all other large final salary) pension schemes. As soon as a neater solution to that problem is found, the rationale for removing the Lifetime Allowance from the rest of the population disappears.
As advisers, we are used to dealing with change, and to telling our clients that we can only make plans based on what we know right now. However, in this situation, the real practical problem is that the “right” solution today could turn out to be expensively wrong tomorrow.
If we knew that the Lifetime Allowance would never reappear in any form, it could make sense for clients to maximise their pension contributions, to reduce their income tax this year. But if the Lifetime Allowance comes back, that could be the wrong answer, and end up costing them more in tax than they save. What is the point of saving income tax at 40% if the resulting pension gets taxed at 55%?
If we knew that the Lifetime Allowance would come back at the same level, then it could make sense for clients who already have pension savings above the previous Lifetime Allowance threshold, to make a large withdrawal now. But if the Lifetime Allowance comes back in some at a higher level, or never comes back at all, that could be the wrong answer. Savers could find that they have used all their Lifetime Allowance, and can’t take advantage of a future, higher level.
If we knew that the Lifetime Allowance would come back at a higher level, then making an additional contribution could be the right answer, or taking some money out of the pension. Or, oddly, both.
Normally, as an adviser, we help clients think about balancing saving for the future against having fun in the present, we help them think about how much risk they want to take with their investments, we discuss how to leave money tax-efficiently to their children. Right now, it feels as if we need a crystal ball to be able to tell them what to do. And that’s not helpful for anybody.
If you would like to discuss any issues raised by this article, do get in touch.
This article does not constitute advice, and no action or lack of action should be taken as a result of what is written. You are strongly advised to consult your financial adviser before taking any action relating to the matters discussed in this article.
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). Your capital is at risk. The value of your investment (and any income from them) can go down as well as up and you may not get back the full amount you invested.
Levels, bases of and reliefs from taxation may be subject to change and their value depends on your individual circumstances.
[1] https://www.gov.uk/government/publications/abolition-of-lifetime-allowance-and-increases-to-pension-tax-limits/pension-tax-limits
[2] Public Expenditure Statistical Analyses 2022, available at https://www.gov.uk/government/publications/how-public-spending-was-calculated-in-your-tax-summary/how-public-spending-was-calculated-in-your-tax-summary