These were a lifetime limit on the amount of tax-relievable pension funds that a person can accrue (the lifetime allowance or ‘LTA’) and an annual limit on the tax-relievable contributions that an individual can pay into a registered pension scheme (the annual allowance or ‘AA’).
The LTA started at £1.5 million, progressed nicely up to £1.8 million, was then pegged back to £1.5 million, and will fall again in 2014 to £1.25 million.
The AA started at £215,000 a year, rose to £255,000, was then severely curtailed to £50,000 (but with the facility to carry forward three years of unused tax relief) and will fall to £40,000 a year in 2014 with carry forward still in place.
Both changes were criticised when they came in – “Surely we should be incentivising pension saving rather than restricting it?”
The opposing argument was that that open-ended tax relief (particularly as most of it was given to higher rate tax payers) could not be sustained in the prevailing economic climate.
Several years on, we have had various forms of ‘protection’ to shelter accumulated funds of a given value, but a number of issues still remain. For example, why do we need both an AA and an LTA? And what about the effect on members of DB schemes, and the tax charges that can arise from them?
For me, the really big issue in relation to non-DB schemes is that it is not the fund level that matters in isolation, the conversion (annuity) rate is also fundamental and that has been dropping for a number of years.
Let’s transfer our gaze across the Atlantic for a moment.
In his 2013 Budget, President Obama proposed to limit the amount of money a person can accumulate in all tax-advantaged retirement plans (IRAs, 401(k) and defined benefit plans) to about $3 million.
Similar to our LTA? Well, the reasoning is very similar – too much tax benefit for those with more than enough to live on, but countered by the argument that this will surely discourage saving.
There is, however, one very important difference – the limit is income-based. I say “about $3 million”, as it is something of a moving target. There is no annual allowance, and the real maximum is the amount that could be used to provide an income of $205,000 p.a. at age 62, increasing in line with inflation - a conversion rate that could also change with actuarial assumptions and interest rates. (Also, it is from age 62 – a few years below our expectations of retirement and state pension age.) So far there has been no mention of what would happen to funds in excess of this amount – our so called ‘protection’ regimes.
Let’s apply this logic back to the LTA in the UK.
In 2004 the National Audit Office reported that the proposed £1.4 million LTA would be broadly equivalent to the earnings cap that applied to occupational pension schemes, and that the number of people affected would be minimal. They used an actuarial conversion factor of £20 to provide £1 p.a. of RPI-linked pension with spouse’s benefit.
The earnings cap in 2004 was £102,000 and two thirds of this would be about £68,000 p.a. The logic for all this was geared towards occupational schemes and not DC pots.
Today, our £1.5 million LTA would buy an income of about £42,000 p.a. (RPI-linked male 65, female 60, 50% widows) and that will decrease even further when we move to £1.25 million and if/when annuity rates worsen.
The advantage with the US approach is that they start with the income and not the fund!
There has been a lot of opposition to the US proposals and it is a moot point as to whether the proposals will ever become legislation.
Interestingly, it is suggested that the President himself has a plan that is not caught by the restrictions, as it is ‘a non-qualified deferred compensation plan’, similar to many US corporate executives. The value of his plan is said to be $6 million - a small amount compared with Mitt Romney, who at one point allegedly had a fund of some $100 million. During the election campaign, it was somewhere between $18.1 million and $87.4 million.
Nice to see some other similarities in our pension regimes!
Mike Morrison
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AJ Bell