Ed Miliband’s recent proposal to cut the Lifetime Allowance (“LA”) for pension savings from £1.25 million to £1 million would deal a further blow to encouraging private pension provision, if implemented. The LA is, in my opinion, a flawed tool in seeking to combat tax avoidance. Reducing the LA further compounds its faults.
A major flaw in the LA is the fact that it is a lump sum measure whereas most pension savers are saving for an income to see them through retirement. The very design of the LA means that it is not sensitive to bond yields – a key component of retirement income. The Labour Leader’s proposed cut comes at a time when bond yields are near lifetime lows. A £1 million consideration will currently secure an inflation-linked annuity of less than £23,000 per annum (for a 65 year-old NW3-based retiree with a 59 year-old spouse, who would receive 67% of the income on the retiree’s death). This annuity is comfortably below the level of National Average Earnings – hardly the stuff of fat cats!
The LA also penalises successful investors. Two savers who contributed the same amounts and gained the same tax relief on those contributions will have different tax exposure at retirement if one’s investments were successful and caused a breach of the LA while the other’s accumulated assets remained under the LA. This different tax treatment is over and above the more successful investor likely paying more tax over the course of consuming the greater accumulated savings.
The LA is not the only tool used in trying to combat defined contribution pension-related tax avoidance but has a companion measure in the form of the limit on contributions that are eligible for tax relief. This latter measure also lacks a link to the cost of providing an income in retirement. However, such a link can be created by revising the limit to take account of changing bond yields (perhaps each year, at Budget time).
Would there not be widespread benefit from reforms to the taxation system that simplified matters by having a single anti-avoidance measure rather than two? Perhaps the anti-avoidance measure could be structured to seek to curb abuse of the system while still encouraging private pension provision. Which party is going to propose scrapping the Lifetime Allowance and simply using the contribution limit to encourage private pension provision/discourage tax avoidance?