The government should consider changing the outdated defined benefit (DB) valuation ratios, not tax allowances, in its quest to find billions of pounds to plug the NHS black hole, Quilter has said.
As the government plans to provide an extra £20.5bn funding for the NHS by 2023/24, pension tax relief has been viewed as one of the likely targets of cuts in the next budget.
But Ian Browne, pensions expert at Quilter told FTAdviser: "With £38bn spent on pension tax relief it’s not hard to see why the chancellor eyes it up when he needs to find extra money behind the cushions.
"However, rather than arbitrary cuts to allowances, it makes more sense to target outdated factors."
The ratio used to value DB schemes for lifetime allowance (LTA) purposes is currently set at a multiple of 20.
This means if an individual takes a benefit of £5,000 from their DB pension, they would use up a monetary amount of £100,000, and therefore use up 10 per cent of the current LTA, which is set at £1.03m.
The LTA represents the maximum amount a saver can save in their pension pot and benefit from tax relief at their marginal rate before they incur a tax charge of up to 55 per cent.
The allowance increased by £30,000 in April to £1.03m, in line with inflation.
The current conversion rate of 20:1 was set in 2006 by then chancellor Gordon Brown, and it was based on the original £1.5m allowance, introduced as part of pensions simplification.
But Mr Browne said while the allowance was raised in the following five years, the conversion rate was not, which made it "vastly out of date" with the current transfer values on offer.
This also meant "there is a discrepancy in tax treatment towards [defined contribution] DC and DB pensions", he said.
The rationale for the 20:1 ratio was that it equated to the amount needed to buy an equivalent annuity on the open market.
Nevertheless, due to low interest rates, the annuity rates have fallen since, and the ratio doesn’t reflect current prices.
Mr Browne explained that individuals are likely to be affected by the lifetime allowance in 2018-19 if they are on track for a final salary pension of more than £51,500 a year.
If the multiplier was to increase to 30:1 this value would change to £34,333.33 a year, and if it was raised to 40:1 the corresponding figure would be £25,750 a year, he said.
Sir Steve Webb, director of policy at Royal London and former pensions minister, agreed that "DB pension rights are currently treated relatively favourably".
However, he said to suddenly increase the rate at which they are tested against the LTA would be a form of "retrospective taxation".
He said: "There would need to be complex transitional arrangements to protect those who were already over or close to the limit under the new rules. This would create yet more complexity.
"As a way of raising revenue it would be far simpler to have an across-the-board reduction in the annual allowance, especially if this was combined with abolishing the tapered annual allowance."
Craig Harrison, managing director of Creative Wealth Management, said it was "clear that the current factors that are applied to DB entitlements for LTA calculations are not representative of the actual cost of providing these benefits".
He said: "This is an advantage that DB benefits have over DC. A reassessment of these factors would go some way to levelling the playing field between DB and DC although as a consequence we would see more DB retirees incurring LTA tax charges.
"That’s great for the chancellor and no so great for those with DB entitlements who are at or in excess of the LTA."
maria.espadinha@ft.com
