The recent cut in the lifetime allowance (LTA) is maddening for a very long list of reasons. I will be writing more on it next week and you can read articles by me and by James Ferguson from last year (the last time it was cut) on why we really, really hate the LTA.
One reason on my list is the fact that it allows those on defined-benefits (DB) pensions to have much higher levels of untaxed income than those with defined contribution pensions.
If you have the latter, you are now to be able to have up to £1m in your account on retirement before being hit by punitive taxes (55% for most people). Today, £1m would give you a pension income of around £25,000 (based on annuity rates). You could, of course, under the new rules, keep the money invested and make a higher income than that – but if you did you’d be taking all the usual risks that come with equity and bond markets along the way.
However, if you have a DB pension (the kind that guarantees you an annual percentage of your average or final salary on retirement) you have no such problems: you can get an income of a good £50,000 (inflation linked!) before your pension pot is deemed to be of a size that makes it liable for LTA excess tax (which is 55% on capital withdrawals or 25% on top of your marginal rate of income tax for income withdrawals).
That’s because, for LTA purposes, DB pensions are not valued relative to any prevailing interest rate but at a rate of 20 times the income you get from it, plus any tax-free cash you take. That’s nice for DB holders, the majority of whom now work within the public sector.
But as Roy Davidson, of Bond Dickinson, says, “If a ‘correct’ capitalisation figure was used for a DB scheme with RPI indexation and 50% spouse’s pension” the multiple used “would be nearer to 40.”
At MoneyWeek, we don’t think any pensions should be subject to any LTAs. But if they are going to be, we do think that the application of the system should be fair to all types of pension scheme. Right now, it really isn’t.