The Law of Unintended Consequences

Do you remember when we had Pension Simplification?  I do.  It promised a new era of encouraging people to save for their retirement with generous rules on the amount you could pay in, with a concurrent limit as to how much your pension fund could grow to before a tax charge would be due at retirement.

The latter was called the Lifetime Allowance (LTA) and in 2006 was set at £1.5m and increased to £1.8m by 2010.  Successive governments quickly cottoned on to the fact that taxing a large pension fund was quite a nice wheeze and one that didn’t seem to upset the voters, so instead of the LTA increasing they started to reduce it; first to £1.5m then £1.25m and eventually down to £1m.

As a concession when it reached £1m they said it would increase by inflation each year thereafter, and it did for a spell until it reached its current level of £1,073,100 a couple of years ago.  At that point it was announced that it would be frozen at that level until 2026 as the country was in a bit of a pickle and we needed the extra tax.

As for the amount you could contribute to a pension, when the ‘simplified’ rules came in the maximum you could pay in was £215,000 a year (yes, you read that right) and this grew to £255,000 (!) by 2010.  HMRC must have been squealing about the amount of tax relief they were losing, as in 2011 this was reduced to £50,000 and three years later £40,000 where it has stayed to this day.

To further compound the difficulty for high earners to accrue a decent pension, in 2016 it was announced this £40,000 limit would not apply to them and they were instead capped at £10,000, which dropped to £4,000 in 2020.

No doubt the boffins at HMRC were happy with their work and ‘sleekit’ extra revenue raised.  However, in the real world these changes resulted in key senior people in the NHS (GPs among them) and other parts of the civil service deciding that it was not worth working extra hours, or at all, and as a result a flood of experienced employees decided they may as well retire early.  This the voters did not like!

At last the penny dropped and the announcement today that the LTA will in fact be abolished is extremely welcome.  It was a nonsense that compared to when the pension rules were changed in 2006 that the maximum amount you could contribute is £175,000 less and at the same time the level that your pension could grow to is £725,000 is lower than it was in 2010.

If the original LTA had grown by CPI it would be standing at £2.39m today.

Now there will no doubt be more devil in the detail and already it has been confirmed that the removal of the LTA will NOT increase the amount of tax free cash that can be taken from a pension which will remain at 25% with a maximum of £268,275 (25% of the existing LTA) or higher for those that have protection.  But it does mean that there should no longer be a tax penalty on the growth achieved by your pension fund.

Of course who knows how long this will last?  Sadly the last seventeen years have shown governments are quite happy to play about with pension rules to suit their needs but hopefully parties on both sides of the divide will have learnt from this and agree on a need for consistency of rules when it comes to people saving towards one of the biggest financial decision of their lives.  

No doubt in the bowels of Whitehall they are already looking at ways they can claw some of this tax back.  It would be no shock if, at some point, pension funds became chargeable to Inheritance Tax,  in which case they would get back many multiples of the tax that has been lost by these changes.  No doubt any such change will be kept for another day.

For our clients the good news is that the announcement and proposed changes contain an increase to the amount that can be contributed to a pension in addition to the removal of LTA tax charges both of which are welcome for younger clients and those approaching 75. 

The new rules, which somehow won’t be ratified until usually summer legislation is approved, start on 6th April. So for right now nothing has changed.  We will be in contact with those of you that are impacted by this change in the next twelve months.