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Who would have thought that pensions and tax could be so emotive?

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Who would have thought that pensions and tax could be so emotive?

16 Mar 2021

3 minute read

There was little in the Budget that affected pensions, despite the perennial rumours that tax relief would be restricted or tax free cash abolished.

Who would have thought that pensions and tax could be so emotive? - news article image

There was little in the Budget that affected pensions, despite the perennial rumours that tax relief would be restricted or tax free cash abolished. The only thing of note, other than the spectre of pension funds being used to invest ininnovative new ventures; (!!!), was the freezing of the Lifetime Allowance for five years, along with a number of other income and capital tax allowances.

Enter the British Medical Association (amongst others) stage left with Shakespearean soothsayer like predictions of an exodus of senior doctors from the NHS fleeing ;huge pension taxation bills; as various pension experts were rolled out to opine on ;middle Britain’ being dragged inexorably towards the spectre of the tax net. 

Watching, listening and reading all this one could be forgiven for thinking that you’d missed some major seismic shift in the pensions landscape, but you hadn't. The problem is that for some sections of society, pensions have become such an emotive issue that anything which has a negative impact, no matter how small or prospective, triggers a big response. 

What is The Lifetime Allowance?

The Lifetime Allowance (LTA) is the maximum pension fund which you are allowed to build up without paying an additional tax charge. Currently the LTA stands at 1,073,100 and was due to go up by 0.5% next tax year as it had been set to increase in line with inflation. Once your pension fund is above that figure, you have an additional 25% tax charge (other figures are used but they are scenario dependent) and can take no tax free cash from any fund above the LTA. The additional tax is quite high when you include the restriction on your tax free entitlement, but for most people even if caught by this tax the tax relief give when contributions were made compared to the tax being paid when drawing the pension evens this out somewhat. 

So no change to what is already in place, simply a freezing of the allowance for five years. So this will hit those who are close to or already above the allowance, but by how much depends partly on inflation. The allowance was to increase by 0.5% for 2021/22, 5,365.50. If it continued at that rate then by 2025/26 it would have increased by just over £27,000. Hardly worth shouting about. However, if inflation jumped up to 2.5% then it could be more like 117,000 -and there is part of the problem; you can make the figures look marginal or large depending on what you assume is going to happen with inflation. To mis-quote, there are lies, damned lies and assumptions. 

How much will 'middle Britain'be affected? 

£1,073,000 sounds pretty big as a pension fund however, with interest rates and inflation low and longevity increasing still, the purchasing power of pension funds has continued to decline. Were you to be buying an annuity at age 65 with such a fund without taking any tax free cash, your income (payable monthly, increasing with inflation and with 50% continuing to spouse 4 years younger than you after your death) the income would be £23,330 per annum. Not exactly millionaire row and yet that few have pension pots of that size anyway.

The impact on the NHS is actually more nuanced than this since doctors are in a defined benefit pension scheme. Since their pension is a guaranteed income for life, there is a calculation performed to come up with an equivalent fund to compare to the LTA. To reach that same LTA figure the pension income required is £53,655 per annum. If the LTA would have otherwise increased by £117,000 as noted earlier, the effective lost increase in pension would be £1,530 per annum out of an income increase of £5,850 per annum. Not a reduction to be welcomed but is that really enough to drive doctors out of the pension scheme and the NHS? 

I suppose each person will have to make their own decisions on that. I simply hope that they will consider their own situation and take advice before simply accepting the hysterical headlines – not every soothsayer was a Cassandra

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