I have always been of the view that we do not need both an LTA and an annual allowance, as it just confuses matters and creates extra administration and cost (indeed this is one of our seven lobbying points).
As it is, we currently have an LTA and in this pre-election phase where kites are being flown it is at the centre of a number of the proposals for the future.
The Liberal Democrats have indicated that one of their platforms for pension reform would be to reduce the LTA further from £1.25 million to £1 million. Having looked at proposals to change the actual rates of tax-relief, they discarded them as being too complicated.
In thinking about the lifetime allowance I turned back to the NAO report from March 2004; The Government estimate of the impact of the pension lifetime allowance.
One particular paragraph stood out (the bold emphasis is mine):
“It is factually accurate that, assuming a 20:1 valuation factor, £1.4 million is broadly equivalent to the maximum pension allowable under the current occupational pensions regime, which includes the earnings cap. That does not mean that such a sum would at any given time necessarily be enough to buy such an income.”
When the LTA finally materialised it was at £1.5million instead of £1.4million, and the earnings cap was just a bit over £100,000. So, the maximum pension referred to was broadly two thirds of the earnings cap – somewhere around £70,000 p.a.
Annuity rates at the time would have refined the appropriate level of pension that could be purchased and some DB schemes that did not require annuity purchase may have been able to offer a higher amount.
The LTA from this April will be £1.25 million and, based on current annuity rates, this means an index-linked joint life pension for a 65-year-old male of some £35,000 p.a.
So, since inception (and in spite of the incremental increases to £1.8 million) the LTA has fallen by some £250,000 and the pension from it has effectively halved because we have just expressed the LTA as a fund with no conversion factor to the relevant income level.
In comparison, a similar policy in the US has been developing to put a maximum on the size of tax-favoured pension funds such as IRAs and 401k schemes, with the limit expressed as that needed to provide the maximum annuity permitted for a tax-qualified, defined benefit plan under current law. This amount is currently $205,000 p.a.at age 62. At current interest rates this would equate to a fund value of approximately $3.4 million.
In practice, this maximum fund value can fluctuate in line with the underlying interest/annuity assumptions.
Now, I am not going to go into the pros and cons of the US proposal but you can imagine that, in a country that espouses the free market with few restrictions on savings, it is not a popular proposal.
The aim is that the fund value will change if the conversion rate is changed, and the focus is on the income at the end.
In the US the prognosis was that only a few high earners would be affected, but that this would be progressive. There was even the argument that some savers would be affected as their employers personally hit restrictions, and would therefore be disinclined to provide pension plans for their employees.
For me, the lesson is that the focus should be on the level of income that an individual can target for the future, not the fund value, and for as long as we have a system that is primarily based around annuities it is the annuity conversion that is important.
This would involve some sort of target income being set by the legislators, and the point of controversy could well be how much that should be.
In the last Budget the Government set a formula for increasing the state pension age that is linked to an external factor; longevity. The idea is that people will be entitled to a pension for one third of their life expectancy. This provides some predictability and objectivity which could well be desirable for income. What level would it need to be? NAE, 50% of NAE or something else?
Don’t get me wrong - I would prefer that we did not have the LTA, as an annual allowance should be sufficient. But if we are to have one, let’s make sure it works and encourages people to target their savings accordingly.
Mike Morrison
Head of Platform Technical
AJ Bell