PensionsOct 21 2020

Lifetime allowance to rise 0.5 per cent next year

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Lifetime allowance to rise 0.5 per cent next year

The pensions lifetime allowance is set to rise to £1,078,900 after inflation was confirmed at 0.5 per cent this morning.

The pensions LTA, which is currently set at £1,073,100, increases every year in line with the consumer price index figure, which was announced this morning (October 21).

The latest rise will mean most savers will be entitled to an extra £1,450 in tax-free cash in 2021/22.

The state pension, which is also linked to the index but is bound by a minimum rise of 2.5 per cent under the ‘triple-lock’ guarantee, will rise by the latter.

The LTA represents a limit on the amount of pension benefit that can be drawn from pension schemes without triggering an extra tax charge – whether in a lump sum or as ongoing retirement income.

According to AJ Bell, although a lifetime savings cap of more than £1m may sound like a lot to savers, based on current rates it would only buy a 65-year old an annuity of £28,000 a year, which is below the average UK wage.

Tom Selby, senior analyst at AJ Bell, said: “The lifetime allowance has been cut repeatedly from a high of £1.8m in 2011/12, creating unwelcome complexity on the way, punishing those who enjoy strong investment growth and causing particular problems for long-serving public sector workers.

“Although clearly dealing with unnecessary complexity in the pension tax system is not a priority at the moment, at some point we hope the government will address these issues.

“We know complexity combined with constant moving of the goalposts puts people off saving for their future, something which as a country we need to be encouraging more people to do.”

Triple lock boost

Today’s 0.5 per cent inflation figure confirms the state pension is expected to increase by 2.5 per cent next April, marking three years in a row where it has increased by more than inflation.

It means the new flat rate state pension will rise by £4.40 a week to £179.60 and anyone on the old system will receive £3.40 more a week at £137.65.

Under current rules, the state pension is increased by the ‘triple lock’ which is the highest of earnings growth, price inflation or a 2.5 per cent minimum guarantee.

The growth in average earnings in the May-July quarter was announced at minus 1 per cent.

Because this was negative, the government had to pass a short piece of legislation (the Social Security (up-rating of benefits) Bill) to give it powers to pay any increase in pensions next April, according to Steve Webb, partner at LCP.

Mr Webb said: “Given that the UK state pension is still low by international standards, the chancellor may feel justified in going ahead with such an increase.  

"He will however face a bigger challenge next year if earnings bounce back and if the triple lock policy would imply an increase of 5 per cent or more.  

"At that point we may see a more ‘flexible’ interpretation of the government’s manifesto commitment.”

Looking forward

For several months there has been widespread speculation that chancellor Rishi Sunak was preparing to scrap the triple lock due to concerns it would become unaffordable. 

Next year, as the country is expected to recover from the coronavirus pandemic and the furlough scheme ends, the OBR said earnings could see an 18 per cent increase.

If average earnings growth increased by this much, the current rules governing the triple lock mean the state pension would have to mirror this.

Sarah Coles, personal finance analyst at Hargreaves Lansdown, said: “Many people have been calling time on the triple lock for years, but worries over its distorting effect on income between pensioners and workers in the fallout from the pandemic could tip it over the edge. 

“This doesn’t necessarily mean some sort of guaranteed rise would be axed altogether. 

“We could see the removal of the 2.5 per cent underpin, or a smoothing of earnings, so the government could technically keep the lock while reducing its power.”

Some have suggested the government could add a smoothing mechanism to the triple lock to track inflation and earnings growth over a two-year period, which could help it save £15bn in 2022-23.

Last month (September 8), the Pensions Policy Institute said moving to a double lock, which has been touted by many across the industry as a solution, would not save money in the short term and said a smoothing mechanism would be a better proposal.

Meanwhile, Aegon had pointed to a smoothing mechanism as an option (August 24), saying the triple lock should be considered over two years rather than one, with state pensioners granted whatever the formula produces next April and the increase in 2022 based on a two-year period.

Steven Cameron, pensions director at Aegon, said: “The state pension is not funded in advance but on a ‘pay as you go’ basis from today’s workers’ National Insurance contributions. 

“The chancellor will no doubt be facing difficult decisions over whether he can afford to retain the triple lock as he supports the economy through wave two of the pandemic and looks ahead to getting the nation’s finances back on track.”

amy.austin@ft.com

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