The government’s decision to freeze the lifetime allowance could yield up to £2bn for the Treasury, double the £1bn it previously projected due to a surge in inflation this year.
The lifetime allowance, the amount a pension holder can benefit from without having to pay extra tax, was frozen at £1,073,100 in the 2021 Budget by former chancellor and current prime minister, Rishi Sunak.
But according to pension consultants LCP, the freeze did not take into account inflation proofing and over the past year inflation has climbed rapidly.
The consumer prices index, a key measure for inflation, reached 10.1 per cent in the year to September 2022. In September 2021, this index sat at 3.1 per cent.
According to LCP, this rise in inflation means the government’s decision to reduce the cost of pension tax relief will raise twice as much for the Treasury between 2021 to 2025/26.
“Inflation has been far higher than expected, which means that the freezing of the lifetime allowance ‘bites’ much more than the Treasury assumed when the policy was announced,” LCP explained.
The government’s policy costings assumed inflation would be 2 per cent or less in each year up to 2025.
Partner at LCP Mike Richardson said freezing tax thresholds is “a highly unpredictable way” of raising revenue for the government.
He added: “When there is a surge in inflation of the sort we have seen recently, freezes on tax allowances can generate far more revenue than expected.
“As well as creating unpredictability for the government in terms of revenues, long-term freezes and changes in policy also make it very hard for individuals to make long-term plans for their pensions and savings”.
Pension tax relief is currently limited by a lifetime allowance, so when pensions worth more than the lifetime allowance are accessed a tax charge is levied on the excess amount.
Where the excess is taken in the form of a regular income, the lifetime allowance charge is 25 per cent on top of regular income tax.
On lump sum withdrawals, the lifetime allowance charge is 55 per cent with no further tax being due.
FTAdviser approached the Treasury for comment.
ruby.hinchliffe@ft.com
