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Letters to MoneyWeek: the iniquitous lifetime allowance

A selection of letters sent into MoneyWeek and their replies from the MoneyWeek team.

I fail to understand the thinking behind the pension lifetime cap.I get that anyone with a pension pot over a certain size might expect to have tax relief reduced on new money going in, or stopped completely after a certain level. But can anyone explain why, if you are able to grow the pot through careful investment over time, the government wishes to penalise you for this, based on what it grows to and not what you put in (and got tax relief on)?

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A higher income in retirement, from whatever source, will in any case attract higher taxation. Doesn't it make more sense for the government to encourage us to grow our private pension pots as much as possible and then, for example, means-test us on our entitlement to the state pension (potentially including no entitlement to a state pension beyond a defined size of pot)? Surely the better we are able to fund our own retirements, the less we will be a burden on the state, allowing government funds to be allocated to those with no such safety net.

Additionally, as you have pointed out yourselves, while a £1m pension fund might seem a huge amount to someone on a modest wage, many people with a 40-year history of saving diligently into a pension will end up getting caught by the cap, and the expected pension from that amount is not at all in the realms of the super-rich. What logic led to the idea of the cap?

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RH

The lifetime allowance, which limits the value of benefits that you can build up across all your pension plans without triggering an extra tax charge, was introduced by Gordon Brown in 2006. It was originally set at £1.5m and increased each year until 2010 when it reached £1.8m. It was subsequently cut to £1.5m in 2012, £1.25m in 2014 and £1m in 2016 (although those who had already exceeded the cap at each point when it was reduced were able to apply to retain the previous limit for their savings).

The rationale behind the lifetime allowance was that people should not be able to take advantage of the tax breaks on pensions to accumulate extremely large tax-free savings that far exceeded what any normal person might need for their retirement. When the allowance was first introduced, the annual limit on pension contributions was much higher, while annuity rates were much more favourable. So regardless of whether the principle was a good one, the amounts involved did not seem entirely unfair.

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However, lower annuity rates and cuts to the lifetime allowance mean that the cap catches many more people. In addition, defined-benefit pensions are valued more conservatively for lifetime allowance purposes, as Merryn notes on page 3, increasing the inequity. Regardless of any original merits the cap may have had, it's now simply a poorly designed tax-grab.

Hunting for value

You made reference in your editorial (MoneyWeek 829) to some good value funds from Schroders and Tim Price. Could you please let me know the names of such funds as I can't seem to locate them in the above edition?

PC

Unfortunately the funds in question weren't specifically mentioned in that issue of the magazine, which is why you were unable to locate them.Schroders runs a number of value-focused funds, with different mandates (UK, Europe and global) and objectives (income and capital growth), all of which are managed by the same team.See Schroders.com for details.

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The fund run by MoneyWeek contributor Tim Price is called the VT Price Value Portfolio and is predominantly a fund of funds that invests in a range of specialist value funds, although it also invests in individual value securities. See PriceValuePartners.com for details.

We have also recently added Temple Bar (LSE: TMPL), an explicitly value-focused investment trust, to the MoneyWeek investment trust portfolio. See issue 830 of MoneyWeek for details.

Investment trusts versus ETFs

How do you reconcile the preference for investment trusts in the MoneyWeek investment trust portfolio with the use of exchange-traded funds (ETFs) in the Lifetime Wealth ETF portfolio developed by members of the MoneyWeek team?

MT

ETFs and investment trusts serve very different roles. ETFs are passive funds that aim to track a specific index as closely and ideally as cheaply as possibly. This makes them very good for asset allocation strategies where you want to divide your portfolio between different types of investment: if you buy a Japanese large-cap ETF, you know that it should deliver similar returns to the overall Japanese market.

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Investment trusts are active funds where the manager aims to beat a benchmark index (or to achieve some other goal such as limiting losses in bear markets that is not simply the same as tracking an index). Hence you would not expect and would not want the trust to deliver the same returns as the wider market.

In addition, many investment trusts have a fairly broad mandate, allowing them to invest in a wide range of markets and assets. This means that the underlying asset allocation of their portfolios are likely to change significantly over time depending on what they feel offers the best value. So investment trusts are less useful for asset allocation strategies, but create the opportunity to earn higher returns if you are successful in selecting managers who can outperform.

Hence our choice of investment trusts or ETFs reflects the difference in strategy between the MoneyWeek investment trust portfolio and the Lifetime Wealth portfolio. The portfolios have some similar objectives: minimise costs, keep trading activity low and focus on long-term returns predominantly though not exclusively through capital growth.

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However, Lifetime Wealth is a pure asset-allocation strategy, which sets a target asset allocation (ie, a certain percentage of the portfolio in each market) and then selects a set of low-cost ETFs to implement that asset allocation. Meanwhile, the MoneyWeek investment trust portfolio selects a set of well-managed investment trusts that complement each other without any fixed asset allocation target for the portfolio although having good diversification between markets, assets and managers' strategies is important.

Writing to MoneyWeek

MoneyWeek welcomes letters and emails from readers, but unfortunately we are not able to publish or reply to all of them. We may edit letters prior to publication. All responses are for information only and should not be relied upon in making investment decisions. Our staff are unable to respond to personal investment queries, as MoneyWeek is not authorised to provide individual investment advice. Please email us at editor@moneyweek.com, or write to us at Editor, MoneyWeek, 8th Floor, Friars Bridge Court, 41-45 Blackfriars Road, London, SE1 8NZ.

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