How will the end of LTA impact pension investing?

But do the changes also mean pension savers, and their advisers, should be thinking differently about how a pension portfolio is constructed?

Thinking about risk

Marc Meshaka, head of investment at Y Tree, an adviser technology provider, says clients investing via a pension may in the past have not wished to take higher levels of risk in their pension portfolio, even if their tolerance of risk is generally high, because they feared that if the risks delivered high returns and pushed the value of the portfolio beyond the LTA limit then the returns would be eroded by the subsequent tax bill, making it not worth taking the enhanced level of risk. 

Meshaka’s view is that some high net worth clients would have kept their riskier investments away from the pension pot for this reason, but now can include them, freeing up the space for other assets in other tax-efficient wrappers.

Josh Ross-Field, investment director at Dowgate Wealth, says: “One other impact of the LTA is it reduced a lot of the benefits of taking risk in pursuit of growth for pensions which were greater than the allowance.

"This is because a significant portion of the upside that you may capture would be taxed away; with the abolition of the limit pension investors can now benefit from these potential gains.”

The LTA reduced a lot of the benefits of taking risk in pursuit of growth for pensions.Josh Ross-Field, Dowgate Wealth

But he cautions against investors against placing all, or most, of their wealth in a tax wrapper, such as a pension, as there is always the potential for future governments to change the rules. 

He adds: “Your investment strategy and risk profile will be determined by a number of factors, including investments outside of your pension, current income and length to retirement. “

As part of the reforms announced in the Budget, the tax-free lump sum an individual can take from their pot at age 57 is capped at £268,275. Previously an investor could take up to 25 per cent of the pot, and as the pot was effectively capped at £1mn, this made the maximum that could be withdrawn tax free just over £250k. 

Jason Hollands, head of corporate affairs at wealth management firm Evelyn Partners, says the impact of the abolition of the LTA on asset allocation in pension portfolios will be limited because the other factors that impact it, such as life expectancy and income requirement in retirement.

Higher risk assets may be those which are highly volatile and so an investor with a shorter-term time horizon may not find them interesting as it may be they come to sell the assets during one of the more volatile periods.

It may also be the case that such assets do not pay an income immediately and are owned for capital gain purposes in the future.

Hollands says potential changes introduced by the government enabling private clients pension funds to invest in illiquid assets such as infrastructure could have a more consequential impact on asset allocation within pensions.

Indeed, Matt Ralph, a partner in the financial advice team at Castlefield, says that while some clients may respond to the changes by increasing their contributions or investing in riskier assets, it could also be that clients who have breached, or are close to breaching the LTA decided to withdraw money now to lock in the tax gain in case a future government changes the policy. 

He says clients who want to own less liquid assets may be better suited to collective defined contribution funds, rather than any other kind of pension, as those vehicles are designed for the purpose.

Alternative remedies?  

One way in which the changes could impact providers is it draws investors with tax efficiency as a priority away from existing structures such as venture capital trusts and the Enterprise Investment Scheme.

As part of his role with Evelyn, Hollands runs the VCT business of the Bestinvest direct-to-client platform.

He says: “It is possibly the case that some of the people who have been dabbling in VCTs or EIS to achieve 30 per cent income tax relief may feel less inclined to do so now there are increased pension funding options.

VCTs and EISs were very attractive and the natural home for those who had their pension funding limited by the LTA.Josh Ross-Field, Dowgate Wealth

"However, those schemes are targeted at very high earners, many of whom will still be severely restricted from adding to pensions because of the continuation of the tapered pensions allowance.”

Ralph says clients will differentiate between the tax efficiency of VCTs and pensions on the basis of risk, that is, the tax reliefs associated with VCTs only accrue because one is investing in higher risk assets, while the pension tax break can be accessed while investing in relatively mainstream asset classes.

He adds that changes to the money purchase pension death benefits announced in 2016 has also increased the attractiveness of pension pots as inheritance tax planning vehicles, potentially reducing the appeal of some alternative tax-efficient investment products.

Ross-Field says: “VCTs and EISs were very attractive and the natural home for those who had their pension funding limited by the LTA. The scrapping of this limit and the increased annual contribution allowance should see greater funds into pensions at the expense of VCT/EISs.”

David Thorpe is investment editor at FTAdviser