Lifetime allowance’s return: keep calm and carry on contributing

The pension landscape is subject to frequent change – sometimes savers benefit, other times they lose out.

There is perhaps no better example of the good, the bad and the ugly than the pensions lifetime allowance (LTA), which placed a cap on what your savings could be worth before being hit with punitive tax charges.

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Throughout the LTA’s 18-year lifespan, which ended in April this year, the government couldn’t resist the urge to constantly mess with it, inflicting all manner of headaches at times, but relieving them at others.

Launched as part of pension simplification in 2006 at a level of £1.5 million, the LTA initially ticked up every year to reach £1.8 million by 2010, but had been hacked to £1 million just six years later. It increased marginally over the following three years, before remaining steady at £1.073 million until 2023.

For anyone with pension savings big enough to get near the LTA, this constant tinkering made pension planning tricky. Whenever the goal posts moved, your savings strategy often had to shift, too.

That’s because any savings that exceeded the limit were taxed at either 55% or 25%, depending on whether you drew the money as lump sums or income, respectively. In most cases, this would wipe out the attractive upfront tax advantages of paying into a pension.

While Jeremy Hunt’s decision to scrap the LTA at his 2023 Spring Budget was widely cheered, not everyone was on board - notably the Labour Party who immediately pledged to reinstate the policy should it gain power.

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So, here we now stand with a 4 July general election just five weeks away, with Labour boasting a commanding lead at the polls. The prospect of the LTA’s resurrection is very real.

This may pose a dilemma for some of you for two reasons.

First, should you withdraw money now to swerve a painful tax charge on any excess down the line? Second, is it worth continuing to make contributions that may take you above Labour’s reportedly proposed £1.5 million limit?

Let’s try to answer these questions.

How many people might be affected by the LTA’s return?

Although a seven-figure pension fund is a pipe dream for many savers, the number of people who have reached this lofty milestone may raise a few eyebrows.

According to estimates compiled in 2022, some 929,000 savers had amassed pension wealth between £1 million and £2 million, 128,000 had pots worth £2 million to £3 million, while 46,000 investors were sitting on pensions of £3 million-plus. And these figures are likely to have increased in the two years since.  

The LTA won’t be reinstated straight away

It’s important to note that reinstating the LTA isn’t going to happen overnight. The recent shenanigans involving its abolishment shows just how sticky the legislative process can be.

The time between Jeremy Hunt’s announcement at the Spring Budget and the policy officially being removed took just over a year. However, HMRC conceded in April that further technical changes were required regarding tax-free lumps (the maximum of which has now been set at £268,275), suggesting things were rushed through a bit too hastily.

There is now so much complexity concerning tax-free cash even experienced pensions technical experts are struggling to explain the rules in layman’s terms.

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One would hope that if Labour romps to victory in five weeks’ time and does decide to bring back the LTA, the party will give itself more time to ensure the rules are clear from the date the policy comes into force.

As former pensions minister Steve Webb noted in a recent conversation with Citywire’s New Model Adviser, the earliest the LTA could possibly see light is 6 April 2026. This may give savers affected by the policy’s return some breathing space to make any necessary changes to their pots.

And there are other complications here which may further delay the LTA’s potential return. In what would be a highly contentious move, Labour has hinted it will provide a carve out for public sector workers, namely doctors who were reportedly retiring in droves a couple of years ago to swerve LTA charges.

It’s tough to ignore, but try not to speculate

Planning your future based on speculation is a risky endeavour. If you make panic decisions with your pensions on the premise that things will change, you might kick yourself later. There is no guarantee the LTA will be brought back, and even if it is, it may be set at a level that doesn’t pose you any problems.

Until we know more, the best approach is to carry on as normal. In a couple of weeks’ time, we should get sight of the manifestos, and it will be interesting to see whether Labour includes its plans for the LTA.

Either way, history tells us that people aren’t retrospectively punished for saving hard and accumulating pension pots above any new LTA limit.

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When the policy was introduced, and whenever the amount has been lowered, the government allowed those with pension funds exceeding the limit to apply to protect their current savings from the tax charge.

There are several protections now in operation, which has done little to ease complexity in the pension space. But a few more knots are preferable to hitting those who saved hard – when the previous rules encouraged them to do so - with eye-watering tax bills.

As such, Labour should have little choice than to offer another batch of LTA protections, not only because it’s fair, but also because the backlash would be off the scale.

Governments should leave pension allowances alone

The problem is not so much the LTA itself but the fact it’s repeatedly been kicked around as a political football. This constant fiddling is more likely to deter rather than motivate savers who need to clearly know where they stand when planning for later life.

There was nothing to stop you from breaching the LTA, but as noted above, the tax penalties for doing so were severe. Any lump sums were taxed at 55%, with any income hit with a 25% tax charge (which would also result in an effective 55% rate tax if you paid 40% income tax on the withdrawals).

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Even with the generous upfront tax relief on offer, the upsides of paying into a pension, rather than say an individual savings account (ISA), diminished once savings surged north of the LTA.

We should also note that the LTA did not only penalise the money you put in, but also any savvy investment decisions you made. If you selected funds or stocks (Nvidia springs to mind) that were particularly successful, knowing that a chunk of this growth could be lost in LTA charges was a bitter pill to swallow. Savers should be rewarded not penalised for backing the right horses.

With all this in mind, one would hope the LTA remains a relic of the past. Whether it will is another matter. It’s understandable that anyone with pension savings north of £1 million may have concerns about the policy’s potential second coming. But the prospect of its return shouldn’t deter you from making sensible decisions today based on the current set of rules.