There are significant issues surrounding both the annual and lifetime allowances, particularly with regard to how these are applied to different types of pension schemes and the challenges this brings to the planning process.
It is harder for those without advisers to navigate these issues and get the best outcome.
The lifetime allowance and the annual allowance came into force on 'A-day' (April 6 2006), but that wasn’t the first time that there were limits on the amount that you could save into a pension.
Prior to this, there was a limit on what you could pay in annually on personal schemes and what you could accrue in your lifetime in occupational pension schemes. Many couldn’t accrue benefits in both types of scheme at the same time.
There were exceptions though, such as doctors and dentists, who could have both types of pension at the same time.
As part of the pensions simplification introduced on A-day, the restrictions on who could save into different schemes were lifted and it was decided eventually that limits were needed that worked for all types of scheme.
This was supposed to be simpler, yet with hindsight we know it didn’t really work out. It is understood that ideally only one test would be required, but that in the end this wasn’t thought to be sufficient, given the size of the allowances at that time.
The annual allowance was planned to reach £255,000 in the first five years and the lifetime allowance £1.8m, with increases being set again by Treasury order after that.
As we know, they never got above these figures and began to drop, adding complexity and bringing more people into the realm of charges.
The lifetime allowance is designed to restrict overall savings into a pension, with the charge recouping some of the tax relief given if you exceed it. However, the tests applied for defined benefit and defined contribution schemes are significantly different.
The multiples used for the DB test haven’t been amended or reviewed in the past 15 years, meaning that there is an increasing discrepancy in the benefits that can be provided by the different types of pension scheme.
You can easily build much greater pension income within a DB pension scheme than you can in a DC scheme.
It is my belief that the lifetime allowance is much more aligned with DB schemes and penalises those in DC pension schemes, especially those who gain significant growth on their investments.
It does appear that it is designed to unfairly tax those that have the least control over their overall benefits and those willing to take an increased risk for the potential of a larger pot in retirement.
This all just leads us to the fact that the lifetime allowance, while requiring review, is best placed to test DB schemes.
The annual allowance, money purchase annual allowance, and tapered annual allowance are all there to restrict the amount saved into a pension scheme in any one year.