The lifetime allowance for pensions has been one of the most heavily discussed topics this year, given that LTA excess charges were removed in the current tax year and the LTA is set to be completely removed as of April 2024.
The level of the LTA has varied over the years, although it has been frozen since 2020-21 and was set to stay at that level until 2026. The effect of the frozen LTA, when combined with rising wages and increased pension contributions, is that the number of individuals paying an LTA charge has shot up in recent years.
According to government data, approximately 5,000 LTA charges were reported for private pensions in 2016-17, generating £200m in receipts. Jumping to 2021-22, this number has sky-rocketed to just shy of 12,000 charges and almost £500mn in receipts.
Effect on the pensioner
These figures may not seem huge in the context of wider HMRC tax receipts, however for an individual who has been diligently squirrelling money aside into their pension, the LTA charge is a harsh punishment for responsible behaviour.
Over the past 15 years, the responsibility to save for retirement has gradually shifted from the employer to the individual via the closing of defined benefit pension schemes, in the private sector at least.
While the government has introduced auto-enrolment to encourage saving for retirement, the LTA does the opposite, putting off savers who are concerned that they might breach the threshold and end up paying punitive charges that were previously in place.
The LTA changes were initially tabled as a tactic to keep senior doctors in work, as many were reducing their hours or retiring early to avoid pension tax charges.
Whether it is successful in that aim is yet to be seen, but it does not seem that the challenges faced by the NHS will be disappearing any time soon.
What next for the LTA?
Chancellor Jeremy Hunt announced the abolition of the LTA in the spring Budget as a two-stage process, and analysts have been scrabbling to understand the fine print of proposed changes to legislation since then.
Adding further uncertainty to the picture, the Labour party immediately pledged to reverse the changes to tax-free pension allowances should they win the next election.
The unpredictable nature of the future of the LTA may be viewed as a battle between the political parties to win favour with voters. However, its effect is unhelpful for those earners who have worked hard to build up their pension pot.
For an individual trying to make sense of the situation, several questions arise.
Should they keep contributing to their pension if they are approaching the LTA threshold? If their benefits exceed the LTA, should they crystallise their pension now to take advantage of current rules? Could they face retrospective tax charges for doing so?
The answer depends on the specific client circumstances and will need to factor in other areas of planning such as inheritance tax.
Given that pensions sit outside of an individual’s estate for IHT purposes, there may have been scenarios where it made sense to continue contributing, even where the LTA had been breached. That argument is even stronger under current rules with no excess charges.
