How to make the Lifetime Allowance fair for all
Pension saving needs people to stop messing with the rules and introduction of independent oversight and a long-term stragetic view, argues Gareth James, head of technical resources, AJ Bell
With politicians having a planning horizon that only extends to the next election, next reshuffle or next scandal it is inevitable that short termism is the order of the day. When politicians raise longer-term strategic issues they tend to get panned by the press and the electorate.
It’s easy to see this because of the rise of the phenomenon of the “new tax disaster” headline. In the last election it was the dementia tax, before that the bedroom tax and whilst Philip Hammond seemed to avoid any massive clangers in his most recent Budget, a number of the measures announced have attracted criticism.
Retirement is something that comes to us all after a working life – even if to some politicians it seems to be coming sooner than expected at the moment – and it could last thirty or forty years. For my parents’ generation half were looked after by their employer and the other half by the state. However, increasingly the responsibility for both investments and managing life expectancy has been passed to individuals. That’s fine but it needs people to stop messing with the rules and understand that this is a long-term business.
If I was (un)lucky enough to be 21 or younger and setting out on this journey called ‘life’ what do I do about the future? I need to save for a house or pay rent, I need to feed myself, but save for retirement? Possibly not that last one, especially as the rules change, a lot; and I hear lots of conflicting messages.
This is where an independent commission would come in. Anyone wishing to tamper with the rules would have to take the proposal to the commission who could ask questions, suggest amendments etc. This is done for benefits through the Social Security Advisory Committee. Why couldn’t we have something similar for pensions?
Applying this to the Lifetime Allowance
It could start off by considering how things have got worse for defined contributions since A-Day. On the Money Advice Service website as I write this, if someone has benefits valued at the lifetime allowance, a joint life annuity for a 60-year-old male and 57-year-old female, increasing by inflation for a drawdown pot of £750,000 is 2.3% or £17,820 a year after the tax- free lump sum of £250,000 has been paid. At A-Day the rate was around 5% and the LTA was £1.5m. That was a lump sum of £375,000 and a pension of £56,250. At A-Day a DB pension would hit the LTA at £56,250 and a lump sum of £325,000. Today it would be £37,500 and a lump sum of £250,000. The DB pension at the LTA has therefore gone from rough parity to double the DC equivalent. At the same time a DB pension can accrue at £2,500 a year, possibly worth £100,000 at today’s transfer values, but you can only put in £40,000 to a DC scheme.
This isn’t fair and is less fair when you consider that investment growth before and after going into drawdown can take you over the LTA. This was a problem at £1.8m but at £1m it hits far, far more people. As correspondents are telling the Work and Pensions Select committee, it is a factor in turning some off saving in a pension. We might all accept that you stop contributions at some point, but let investment growth continue tax-free.
What would I want a commission to consider? To address the DB vs DC unfairness that has developed, how about considering doubling the LTA to £2m; valuing DB benefits at 40:1; stopping DC contributions when the value of the DC fund is over £1m; and restricting tax-free lump sums to 25% of £1m, so half of the new LTA. A further benefit here is those with protection for £1.5m or £1.25m will see this drop away as the £2m LTA and no contributions covers it.
Our DC client would be able to get a lump sum of £250,000 and at today’s annuity rates a pension of £35,640. Our DB person would get a lump sum £250,000 and a pension of £37,500. That would be closer to the A-Day position without much cost.
We need a commission because we do not want pensioners to be solely reliant on the state. We therefore need to ensure stability and fairness to give people confidence in the system. We could alternatively leave it to the politicians and the civil servants with their reformed DB pensions (they’re now career averaged rather than final salary) but I think we’d prefer a longer-term strategic view.