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Tony Byrne: Beware the lifetime allowance Venus flytrap

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There was a time when, on a change of government, there was an unwritten rule the incoming party would not reverse the legislation introduced by the previous one. In addition, the concept of retrospective legislation did not exist. This was considered fair and reasonable, especially because it allowed individuals to plan their lives in accordance with the laws of the day without expecting wholesale changes that were unforeseen and unplanned.

This all changed in 1997 when Gordon Brown introduced the tax bombshell to pensions by disallowing the reclaiming of tax credits on dividends. In one fell swoop, this robbed pension investors of £5bn a year. It was the government’s first stealth tax on pensions. It was also the first time we had witnessed retrospective legislation. Since then this tax raid now costs pensioners £10bn a year.

Labour introduced the lifetime allowance in 2006 to punish the fat cats, the original plan being to increase the limit every year. It reached a peak of £1.8m in 2011/12 but has since reduced to £1.25m. From 6 April 2016 it will be reduced to £1m. This now means ordinary people who have made sacrifices, worked for many years and voluntarily paid more into their pensions will increasingly be hit by this retrospective tax charge.

Interestingly, many people with final salary pension schemes will get caught out by these new rules because they will be blissfully unaware of how valuable their pensions are. Take an individual with a final salary pension of, say, £40,000 and a tax-free cash lump sum of £120,000. For LTA purposes, the pension is valued at £920,000. If that person also has a personal pension of, say, £150,000 he/she will be caught under the new limit from 6 April 2016.

I consider this to be a Venus flytrap. You get lured into paying into a pension because of the wonderful tax benefits and then once you have built a sizeable fund you get clobbered for more tax. The Government knows just how much is invested in UK pension schemes and it is truly a soft target.

Interestingly, judges, senior civil servants and MPs are exempt from the LTA. Clearly, it is one rule for them and one rule for us. This is the type of policy you expect from a dictatorship rather than a supposedly democratic government.  I think it is truly shameful behavior.

I have never understood why you need a LTA anyway when you already have a contribution limit. You should have one or the other. You certainly should not be penalised for paying a lot of money into your pension and managing it skillfully.

Clearly pensions simplification has become pensions complication again.  What is more I can see the next pensions misselling scandal on the horizon once people can access their money purchase pensions in full from next month.

It is my view the Government will face a huge backlash in the future once people realise what a hash they have made of our pensions.

Tony Byrne is financial planning director at Wealth And Tax Management 

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Comments

There are 18 comments at the moment, we would love to hear your opinion too.

  1. I agree with Tony on this 100%.
    Both left and right are now playing to the crowds with the politics of envy as opposed to doing what is right and fair.
    Pension complification, jiggory pockery and hidden taxes. Judges, civil servants and politicians should set an example and do the right thing and put themselves in exactly the same position that their constituents are with regard pensions.

  2. Totally agree with Tony and Phil. Shameful.

  3. I agree that these kinds of changes have extremely negative effects.
    But it is not correct to say that senior civil servants are exempt from the LTA. It applies to a civil servant in exactly the same way as it applies to anyone else.

  4. They need to increase the multiplier in Final Salary schemes from 20 x Pension + Tax Free Cash to something more like 35 x Final Salary = Tax free Cash. That is a fairer system. I have said before that I think £1 million in a pension pot, that has been subsidised by the tax payer (ME and YOU and the rest of the UK tax payers) is more than enough. If people with more money want to save for their retirement on top of this then they need to pay their taxes. What is totally unfair is that someone with a Final Salary can nearly get an income twice as much as a money purchase person without having to pay a Lifetime Allowance tax charge. HOW IS THAT FAIR?

  5. I didn’t see anyone complaining about changes to pensions when the 55% tax charge on death was removed. It’s funny how not all tinkering with pensions receives negative comment.

    Also, if everyone thinks the rules for DB schemes are so unfair there is nothing to stop employers setting up new DB schemes.

  6. Sorry Tony but in what way was the change in 1997 to the future taxation of a pension investment fund retrospective legislation? If we take as our definition of retrospective any change which affects the future position of something which we began earlier, then pretty much any change in legislation becomes “retrospective”. Hardly “stealthy” either – if the tax change were a stealth bomber it wuold have looked rather like a colourful balloon and had the flying ability of a brick. What with comments on dictatorships, fat cats etc this really doesn’t add anything to any sensible discussion on the impact of changing pension legislation.

  7. @David Stoddart, well whilst your idea would make things more even, it would simply mean that even more people would be caught by a retrospectively applied tax, so you have an interesting definition of fairness. People have not received tax relief on £1 million, they have received tax relief on the contributions. It seems wrong to me to penalise people for investing successfully, given that the additional investment returns will subsequently be taxed at their marginal rate of income tax when taken as income in any case. Maybe there is a case for limiting the amount of tax free cash over a certain limit but I can’t see that it is fair to limit the end result of the total fund by effectively levying a punitive tax on investment success.
    @James Hurdman – name one employer who has set up a final salary scheme from scratch in the last 10 years where no scheme previously existed. I think you will find that there is plenty to stop them from setting up new DB schemes.

  8. Sorry Tony but in what way was the change in 1997 to the future taxation of a pension investment fund retrospective legislation? If we take as our definition of retrospective any change which affects the future position of something which we began earlier, then pretty much any change in legislation becomes “retrospective”. Hardly “stealthy” either – if the tax change were a stealth bomber it wuold have looked rather like a colourful balloon and had the flying ability of a brick. What with comments on dictatorships, fat cats etc this really doesn’t add anything to any sensible discussion on the impact of changing pension legislation.

  9. nwarendell | 30 March 2015 2:51 pm whilst the same rules apply they favour those in DB schemes (mainly public sector these days alas).

    A DC pot of £1 million would provide an annuity of around £27k p.a. with 50% spouse and RPI built in. A DB scheme could provide a pension of £50k p.a. with 50% spouse and RPI built in but this wouldn’t breach the £1 million LTA due to the simple way of multiplying the pension by 20 to get a capital sum.

  10. Edward: It was retrospective because people and employers saved money in pensions thinking that it would be invested tax free. And employers and insurers made certain promises to future annuitants and retirees which were partially based on the assumption that growth via equity dividends would be tax free.

    To make that change non-retrospective, HMG would need to have established two separate classes of pension funds – pre-1997 and post-1997 – with pre-1997 benefits (including regular premium arrangements which had not been altered post-1997) able to reclaim the 10% dividend tax benefit, and post-1997 benefits not.

    I make no judgement on whether this would be right or practical, however that is what would be required for the 1997 change to be non-retrospective.

  11. Mr Gannon, the reasons why DB schemes have been closing at a rate of knots and not being replaced is well documented. You have not addressed my point though, which is that if there are people out there who think the rules are “unfair” they can do something about it – set up a DB scheme.

  12. sorry @JamesHurdman I had no idea you were serious about your suggestion. But to answer your point — some of the barriers to this happening are as follows a) only employers can set up final salary/defined benefit schemes b) such schemes would need approval before being established c) in order to gain approval an actuarial analysis would need to be carried out and paid for d) the employer would need to set aside very large amounts of capital to fund future final salary 0ension liabilities e) an investment manager would need to be appointed f) the cost of funding the scheme would run into very high numbers g) most employers would struggle to convince shareholders of the benefits to the employer of establishing a scheme with open ended liabilities so would struggle to divert sufficient capital to set up and fund such a scheme. So only employers who think the regime is unfair can carry out your suggestion, and only those with the very large pockets can afford to follow such principles. Didn’t realise you were making a serious point.

  13. @ Brian. I didn’t say I agreed with the LTA rate of tax charge @ 55%. I believe a fairer LTA Charge would be 40% on the whole lot over the lifetime allowance. As if someone paid HRT and invested their money eg. £60,000 @ 4 % = approx. £88K. £100K (including relief at 40%) = approx. £148K then take 40% off and you are left with £88K. That to me is a fairer way.

  14. Mr Gannon, you have just outlined the “well documented” issues with DB schemes that I was referring to, and then gone on to say that employers can set up DB schemes. I am not sure if you realise it, but you have just agreed with me.

  15. @David – think we are on the same lines there.
    @James Hurdman – I am not sure if you realise it but most people are not employers. Most people who work are employees or are self employed or operate small businesses. We most certainly do not agree with each other. Or should that be MR Hurdman?

  16. Mr Gannon, I never said that “most people” can set up a DB scheme. That would be patently absurd. I said that “if everyone thinks the rules for DB schemes are so unfair there is nothing to stop employers setting up new DB schemes”. The penultimate sentence in your third comment on this topic says the same, but refines a definition of the corporate market who could establish a DB scheme. For brevity, I hadn’t defined the market in my comment; I was only talking of the principal.

    As for “most people”, they won’t ever get close to the lifetime allowance in a DC scheme or the £40k pa in a DB scheme that is referred to in the article. So it won’t be a problem for “most people” anyway, particularly younger savers who are struggling with the cost of living, busy paying off student debt and saving to try and buy somewhere to live (hopefully before they hit 40). I have sympathy for people who are immediately affected, but for them to now be able to pass pension wealth on to individuals of their choosing on death is great. Will DB members be able to do this? No, only if they transfer. That is the trade off and is first point I made in my first comment.

    As for my use of “Mr”, what can I say? My mother taught me to be polite.

    On a broader level (not to you directly Mr Gannon), rather than the LTA discouraging pension saving, shouldn’t we, as an industry, now use the LTA to encourage pension saving, rather than it being viewed as a “tax on aspiration” that I have seen some commentators describe it as. Personally speaking, I will be turning it into a positive and getting clients to view hitting the LTA as a target to achieve, a badge of honour to wear. A bit of Nudge Theory and anchoring put to positive use.

  17. @Mr Hurdman – in regard to your use of nudge theory and anchoring I am glad that you have your own way of doing things when it comes to motivating and inspiring clients. Just like your personal interpretation of what constitutes following your mother’s guidance to always be polite, I maybe have a different way of speaking to my clients and a different definition of what polite forms of address are. All the best Mr Hurdman

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