Making allowances? The future of pensions tax

  • Learn about recent developments with regard to the lifetime and annual allowances
  • Grasp the arguments for and against a reform of these allowances
  • Comprehend the factors that could influence the government's stance on the issue in future
Making allowances? The future of pensions tax

The end of summer always heralds the return of several of the nation’s favourite sports. And while the average Briton will be speculating about who will win the Premier League, those in the financial sector are just as likely to be pondering possible legislative changes being lined up by politicians as they return from their own summer break.

The annual Budget now takes place around the start of December, having been moved to the end of the year by chancellor Philip Hammond in 2016. But a change of season has done little to stop further speculation about one topic in particular.

Mr Hammond’s predecessor, George Osborne, was rumoured to have been considering the ‘pensions Isa’ back in 2015, and potential reform of pension taxation has never been far from the industry headlines ever since.

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The latest voice to weigh in on this debate is the Treasury select committee (TSC), which published a report on household finances and savings in July. Among its recommendations were the abolition of the Lifetime Isa, the scrapping of the state pension triple lock, and the introduction of a flat rate of pensions tax relief – all of which have been proposed by other industry figures and commentators over the past 18 months.

Arguably a more eye-catching recommendation was the suggestion that the lifetime allowance (LTA) be ditched and replaced with a lower annual allowance.

Weighing up

Here at least, the TSC appears to be attempting to strike a balance – giving with one hand, and taking away with the other. It has echoed calls from advisers and the pensions industry for an unlimited LTA, while simultaneously suggesting the £40,000 annual figure be reduced to an unspecified amount. 

Steve Webb, director of policy at Royal London, says those who are worried about the annual allowance are “atypical of the great British public”. The annual allowance is currently £40,000 – though it reduces for those with higher incomes – and the average income in the UK is £27,000. 

Mr Webb says: “Far from paying £40,000 into a pension in a year, the average Joe doesn’t even earn £40,000 in a year... you cannot write an entire system around extreme cases.”

He adds that while his preference would be for the government to stop tinkering with how pensions are taxed, he would be in favour of the TSC’s recommended changes to the allowances.

He adds: “The LTA is a tax on success. If the package on offer was no LTA and a simple, straightforward annual allowance, I would be willing to accept a cut in the annual allowance.”

Chop and change

Since their introduction in 2006, both the LTA and the annual allowance have been cut dramatically.

The annual allowance was originally set at £215,000 and the LTA was £1.5m, before increasing to £255,000 and £1.8m, respectively, by 2010. Both have subsequently been slashed; the annual allowance currently sits at £40,000, while the LTA is now £1.03m. Chart 1 shows how the LTA has changed in recent years.

Some adviser clients may have been insulated somewhat from these changes, thanks to a significant rise in the number of people using protection to guard against allowance changes. Data from Retirement Advantage shows that more than 60,000 used such methods in 2016-17, up from an average of 16,000 a year between 2013 and 2016. Chart 2 shows how existing LTA limits affect those with fixed protection.