DB to DC transfers serve to highlight LTA inequalities
Confusing, cumbersome, discriminating – it’s time to scrap the Lifetime Allowance, argues Mike Morrison, head of Platform Technical, AJ Bell
2006 saw the introduction of ‘pension simplification’, a phrase that still invokes something between a laugh and a sigh when it comes up in conversation. In fact, pension simplification was so ‘simple’ to introduce, it was delayed by a year to give everyone some extra time to implement it!
One of the components of ‘simplification’ was the ubiquitous Lifetime Allowance (LTA), and it is a mechanism that still enjoys a central role in pension planning today.
In the run-up to its introduction, there was a lot of work done to justify the proposed level of the LTA – indeed there was a National Audit Office report done in 2004 called ‘The Government estimate of the impact of the pension lifetime allowance’.
One of the findings of the report suggested “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.” (My emphasis)
When it was finally implemented, it was at £1.5 million instead of £1.4 million. And at that time the occupational pension scheme earnings cap was just a bit over £100,000. So, the maximum pension was £75,000 – broadly three quarters of the earnings cap.
Since then, we had a series of prescribed increases, reaching a peak of £1.8million in 2010/11 and 2011/12 before we started the current trend of decrease, with the latest fall from £1.25 million to £1 million from April 2016 (see table below).
2006/7 £1.5 million
2007/8 £1.6 million
2008/9 £1.65 million
2009/10 £1.75 million
2010/11 £1.8 million
2011/12 £1.8 million
2012/13 £1.5 million
2013/14 £1.5 million
2014/15 £1.25 million
2015/16 £1.25 million
2016/17 £1 million
Now, a lot has been written about the LTA and very little of it has been positive – “why do you need a lifetime allowance and an annual allowance?” “It’s a tax on investment growth!” and add to this the administrative burden of keeping a record of all the different types of protection.
For me, however, the major inequities of the LTA were, as I highlighted in the quote above, the different treatment for DB and DC, the income that can be provided and even issues with moving from one regime to another.
When the LTA reached £1.8 million, a DB pension of £90,000 p.a. (using the 20:1 conversion) would probably have been below the LTA. Following this year’s drop in LTA, that amount will be some £50,000 p.a.
The DC environment is sadly very different, as annuity rates have continued to fall. (Some recent research from Moneyfacts showed that annuity rates have halved since 1994!)
The new LTA of £1million would buy nearer to £30,000 for a joint life annuity RPI linked at age 65. The problem obviously being that DB enjoys a fixed conversion rate while DC is subject to a fluctuating annuity rate.
The difference between the two conversion methods can be brought into focus when there is a transfer between the two regimes, and the renewed interest in DB transfers means that this is under the spotlight more than ever.
If we use a scheme pension of £50,000 p.a. as our rule of thumb for an LTA of £1 million, then a scheme pension of £40,000 p.a. would not exceed the LTA. If, however, that £40,000 p.a. yielded a CETV in excess of £1 million, a transfer could drop the member in some serious LTA hot water!
The LTA can be confusing and administratively cumbersome. In a pension world where everything seems to be up for grabs, abolishing it could make pensions a bit easier to understand. And perhaps it might even offer some encouragement to those discouraged by any removal of higher rate relief to continue saving for later life.
Visit the AJ Bell adviser website