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Preparing for a slashed pension lifetime allowance

This article is part of
Key Adviser Issues in Budget 2015

While the latest reduction to the lifetime allowance may not sound like it will impact the average person, industry experts warn it could hit those with average incomes.

The government will reduce the lifetime allowance for pension contributions from £1.25m to £1m from 6 April 2016. This is the ninth time in nine years the rates have been changed.

Transitional protection for pension rights already more than £1m will be introduced alongside this reduction to ensure the change is not retrospective. Details of that transitional protection have yet to be published, but it comes in addition to five existing protections already in use.

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A minor concession was offered in that it was announced the lifetime allowance will be indexed annually in line with CPI from 6 April 2018.

The chanellor said the move will raise £600m for the Treasury which is going towards ensuring the Budget is fiscally neutral. He eschewed a cut to the annual allowance as this would hit some long serving public sector workers, he said.

Many have called for the lifetime allowance to be scrapped and the annual allowance set at a flat rate. Pension tax relief as soared to £4bn a year and some suggest higher earners account for three-quarters of this despite only making half of contributions.

The Treasury added that only 4 per cent of savers will be affected - but that did not stop commentators complaining that in a short space of time this will be impacting average earners.

Gary Shaughnessy, chief executive of Zurich UK Life, says lowering the threshold could end up impacting middle earners, not just higher earners, especially given the effects of inflation on savings over a long period.

Although the chancellor has said that the lifetime tax allowance will be index linked from 2018, Mr Shaughnessy says this will only partially mitigate the impact of this change for savers who have been doing the right thing for their retirement.

Phil Smithyes, managing director at Crowe Clark Whitehill Financial Planning, warns the reduced lifetime allowance will create a funding dilemma for clients with more than 10 years to go to retirement.

He says: “This is, no doubt, the price to be paid for increased flexibility and access to pension funds.”

Brian Henderson, partner at Mercer, says the reduction in the annual lifetime allowance to £1m will hit clients who are defined contribution savers harder than defined benefit members.

He says this is because under current rules, a DB pension of £50,000 will be impacted by the penalty tax charge. In contrast, Mr Henderson says an equivalent DC saver will only be able to receive a much smaller annuity before they are affected by the penalty tax charge.

He estimates that within a couple of decades a DC member will typically be able to buy a pension of less than £25,000 a year based on current annuity rates

Mr Henderson says: “On the face of it, £1m is a huge amount of money and beyond the reach of many. However, the impact of this reduction on DC savers reminds us that they continue to be the poorer relation when it comes to pension provision.