LTA 2023

LTA 2023

Today’s post looks at the abolition (and potential restoration) of the Lifetime Allowance, and at what investors should do about it.

The Lifetime Allowance

The perverse and hated (( By me, at least )) Lifetime Allowance for pensions (henceforth the LTA) was introduced by Gordon Brown in 2006.

There are four reasons why the LTA was a bad idea:

  1. There was an (annual) limit on pension inputs, so no limit on outputs was necessary.
  2. The chosen implementation of the LTA was very complicated, with lots of trigger events (“crystallisations”) that led to a higher tax rate, and more than one penalty rate depending on how you take your pension benefits.
    • This makes is expensive for HMRC to operate, particularly when it isn’t one of the big revenue raisers.
  3. Working out whether you would breach the cap was very difficult.
    • Pensions are a 50-year product (25 years in, 25 years out), and predicting investment returns and inflation over such a timescale is impossible.
    • This led people to err on the side of caution and stop making contributions.
  4. The LTA was too small.
    • It started at £1.5M and was rarely index-linked; it rose to £1.8M before falling back to £1M.
    • This created a lobster pot problem where those who planned for £1.8M of benefits found they were over the new lower limits.

The LTA was finally abolished by Jeremy Hunt in March 2023.

  • The Labour opposition, leading in the polls, immediately pledged to reintroduce it (other than for doctors, bizarrely) if they form the government after the election that is due in the next couple of years.

So what should an investor do?

  • Let’s start with who we are focusing on, and what has changed.
Scope and timing

We will focus on the people worst affected by the LTA:

  • those with bigger pots, and
  • those who thought that they would have bigger pots in the future.

The former group could take advantage of “protection” (at £1.8M, £1.5M, or £1.25M) as the LTA was reduced but at the cost of not being able to make further pension contributions.

A lot of people use pensions as part of IHT planning, but we won’t be looking at that today.

  • We’ll also ignore the “doctor problem” of DB pension accruals exceeding the annual allowance, leading to a charge.

The LTA is now gone (( Strictly, the penalty is gone, and the LTA will disappear in the next tax year )) but the 25% tax-free commencement lump sum has been frozen at 25% of the old limit, which equated to £268K.

  • So instead of comparing withdrawn benefits with a cap, we will all move to comparing tax-free cash withdrawn against a cap.

Those with protection are allowed 25% of their protection amount.

  • They are also now allowed to make further contributions without losing their protections.

Additionally, the annual allowance has been increased from £40K to £60K, and the Money Purchase Annual Allowance (the MPAA, applied to those who have taken pension benefits beyond the tax-free lump sum) has been increased from £4K to £10K.

  • Contributions are still limited by earnings, and non-earners can only put in £3.6K pa.
See also:  Tax Avoidance

The general election is due by January 2025, so we probably have two tax years of the new regime.

  • Assuming that Labour wins the election and restores the LTA at around £1M, they will probably have to bring in more protection for existing pots.

Pensions are treated as deferred pay, so clawing them back is tricky under UK law.

There’s also the option to crystallise some pension pots before the election, to guard against Labour tinkering with the tax-free lump sum.

What to do?

I haven’t made any pension contributions for many years, and my partner makes the minimum contributions under the workplace auto-enrolment scheme.

  • Now that the LTA has gone, I’m somewhat annoyed by the missed contributions, given that they would no longer lead to an LTA charge.

But at least the penalty tax has gone, and perhaps this year we’ll put in more.

  • The limiting factors will be earnings and cash flow.

I’m semi-retired and whilst my partner is working at the moment, a variety of bureaucratic delays (on tax refunds, pension payments, and inheritance) mean that we may not have any spare cash this year.

  • I’m also limited by the MPAA since I draw on my pension every year.

Although the dust has settled on the March budget, it’s probably too early in the tax year for me to decide how much to contribute.

  • I need to keep my cash flow projection up to date and work out how to prioritise between ISAs, pensions, and VCTs.

Until next time.

Mike is the owner of 7 Circles, and a private investor living in London. He has been managing his own money for 40 years, with some success.

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5 Responses

  1. Al Cam says:

    Re: “Although the dust has settled on …”
    FWIW, I am still struggling to see how making such contributions can be beneficial beyond ‘managing IHT’ and deferring taxation to take advantage of assumed beneficial future tax rate rate differentials, especially with the PCLS capped at the existing LTA. What might I have missed?

    • Mike Rawson says:

      As long as there’s VCT/EIS and I have enough cash outside tax shelters, it’s not really deferral. Decumulation is a cash flow game. Plus there is corporation tax to consider and the PCLS is capped at your personal level of protection, not just last year’s LTA.

      • Al Cam says:

        Seems there are lots of considerations that I am not particularly familiar with e.g. VCT/EIS and corporation tax.

        I think I sort of understand your earnings/cash flow observation, but should this not be weighed against the risk of LTA re-introduction and/or further punitive changes, such as say the introduction of NI on pension payments? In a simple vanilla case of say 20% income tax on the way in and 20% income tax on the way out the only gain I can see is from the PCLS (if available) and IMO it is not worth it at a max of £500 per £10k!
        Look forward to learning more in due course.

        BTW, I agree 100% that income drawdown is far better for managing personal cash flow (and income tax situation too) than DB pension payments as the latter cannot be paused if and when you have some earnings!

        • Mike Rawson says:

          As things stand, it’s 40% relief on the way in (ignoring corp tax and NICs) and 0% on the way out, from a pot with tax-free growth. If the LTA is reintroduced Labour will have to offer further protection. If they merge NICs and income tax (which I doubt, since NICs are nominally pension contributions, and there would be a backlash from public sector DB pension types who are Labour supporters) then I guess I would spend my ISAs until Labour lose an election.

          • Al Cam says:

            Thanks.

            Tax arbitrage with those percentages sure changes the calculus!

            40%/20% may not be too shabby either, but the proposition becomes less attractive if taxes on the way out increase.

            ISA’s could be vulnerable too – but lets hope not.

            My days of being a zero percent income tax payer are now behind me.

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LTA 2023

by Mike Rawson time to read: 3 min