The lifetime allowance is to be cut again.
The lifetime allowance is a key component of the pension tax rules. It effectively sets the normal maximum value of retirement benefits, beyond which a tax charge of up to 55% may apply. When the current ‘simplified’ (sic) pension tax rules started life in April 2006, the lifetime allowance was set at £1.5 million, with increases to £1.8 million scheduled through to 2010-11.
However, after 2010-11 there were no more lifetime allowance increases. Instead there were cuts in 2012 (to £1.5 million) and 2014 (to the current £1.25 million). The Chancellor announced a third reduction to the lifetime allowance in the 2015 Budget, taking the limit down to £1 million in 2016-17. Two years later, the lifetime allowance will become index-linked, albeit to the CPI rather than the RPI or earnings. As the graph below shows, had the original £1.5 million had been RPI-linked from the start, by April 2016 it would have been around double the proposed level.
We expect that there will be another set of transitional protection rules covering the cut, allowing anyone with pension benefits worth more than £1 million in April 2016 to apply for a higher personal lifetime allowance. If your retirement funds are likely to be worth over £1 million by next April, or already are, you will need to consider taking advantage of these.
Although the change is not legislated for in the Finance Act which recently received a rushed Royal Assent, there is little chance of the £1 million limit not becoming a reality, given that George Osborne has retained his position as Chancellor to the Exchequer for another term.
£1 million may sound more than adequate for a pension pot, however, at current annuity rates, it would only buy you an index linked pension of about £2,750 a month before tax at age 65.
If you think you might be affected by the proposed reduction in the lifetime allowance, or would like to discuss anything mentioned in this article, please get in touch.