Lifetime Allowance: what is it good for? Absolutely nothing. Fans of Edwin Starr, Frankie Goes to Hollywood or Bruce Springsteen may remember the song “War: what is it good for?”.
A few lyrics for those who don’t:
War: Huh huh; what is it good for?
Say it again….
Oh no-there's got to be a better way
Say it again
There's got to be a better way-yeah
What is it good for?
Replace “War” with “LTA” and this remains true. It is good for nothing and has to go. The Chancellor could do worse than abolish it next week in the Autumn Statement, although I admit that he would need to find some savings elsewhere or take a fiscal hit.
The pensions industry has not been vocal enough about what a horrendous mess, and completely flawed concept, the Lifetime Allowance (LTA) is. It really has to go. This is not left versus right, socio-economic policy or rich versus the less well off. It is simply theoretically poor and should be abolished. This needs to be said more loudly.
What is wrong with it?
Unpredictable risk of excess
A person cannot know in advance whether they will breach the LTA. Strong investment returns just one year before retirement could take someone over, so with 10 or 15 years until retirement the future investment uncertainty makes it impossible to know. £400,000 fund 15 years in advance? You may breach, you may not! This makes planning contributions extremely difficult. If I pay more now will I lose 55 per cent of it? Also, what will the future LTA be? It was £1.8m not long ago and scheduled to be £2m. It is now £1m. Planning long term anyone?
Distortion of investment choices
The LTA distorts investment choices badly. If you have a risk of excess, then why take investment risk? With any excess taxed at 55 per cent, the normal risk/return trade-off for investments is smashed to pieces. How is it good for the nation to force investors into extreme conservatism? How good is it for individual savers to invest conservatively with potentially 40 or more years ahead of them, both pre-retirement and post-retirement in drawdown?
For many years the effective pension limit for defined benefit schemes has been around twice that for defined contribution schemes. Why? One suspects that if defined benefit LTA limits were a guaranteed pension of around £25,000 to £30,000 per annum the policymakers, all in defined benefit schemes, might make different policy decisions… Whilst mentioning defined benefits, let us note that for members close to the limit the testing and assessment is a complex mess, which serves consultants quite well but no-one else!
Senior executives’ interest in workplace pensions
The LTA takes most executives out of their companies’ pension arrangements. This cannot be good for their engagement with, and support for, these workplace pensions. A tight Annual Allowance and no LTA could avoid this. All in all, it is a nonsense.
Why does it exist? When moving from old-style limits to the new regime in 2006, the LTA retained an overall "approved pension scheme" limit; albeit a monetary amount not related to salary. This simply does not work, especially for defined contribution schemes. The policy intention is to limit lifetime pension tax relief. Indeed the changes to the LTA in the last five years fed directly into the Treasury’s national deficit calculations. One line in the deficit was directly related to reduced tax relief and taxation of surpluses.
But where did the idea of a lifetime limit come from?
Nearly all taxation is based on tax years, not a lifetime! An appropriate Annual Allowance is a far superior method to control tax relief, as it can restrict tax relief as required. There is legitimate debate over higher rate relief – flat rate, tapering at the higher end and all that jazz. That is a legitimate socio-economic, fairness and effectiveness of wider pensions and savings policy debate. Fine. Opinions vary!
But surely the Annual Allowance, combined with tax relief rules, is the right tool for this, NOT the LTA. It is so flawed a concept it simply must go.