Reviving the lifetime allowance hurts those aspiring to good pensions

A stop for the wealthy and just another example of how the Tories pander to older, wealthier voters.

This was the thrust of the reaction in some quarters to the budget announcement that the lifelong pension benefit would be abolished.

Six weeks later, the dust has settled on Jeremy Hunt’s announcement, but savers appear to be cautious, with an AJ Bell survey saying three-quarters expect this tax trap for pensions to return.

That’s not surprising, because almost as soon as the chancellor declared he would scrap the lifetime allowance, Labor claimed they would pay it back if they were elected.

Shadow Chancellor Rachel Reeves said Labor would reinstate a cap on the amount that can be put into a pension pot without tax penalties, calling it an “untargeted tax cut for the richest 1 percent.”

She didn’t say whether it was the same £1.07m cap that would set her party back, nor did her colleague Angela Rayner in her subsequent comments. But Labor also declined to confirm that a revived cap would be higher or fairer than the outgoing one.

A common thread in other criticisms has been that abolishing the lifetime benefit increases intergenerational unfairness because it benefits older savers.

But is this story completely correct?

At first glance you might think so. After all, a pension of £1.07 million seems like an unfeasibly large sum for a normal person to save.

But when you turn that number around and look at the retirement income that such a pot can buy, you realize why many longtime critics (myself included) of the lifetime allowance have denounced it as a tax on the aspirations of younger savers.

The £1.07 million lifetime stipend would have bought an income of £42,800 a year from a pot drawn at a standard rate of 4 per cent per annum.

That may be big compared to most, but it’s hardly a fat cat’s territory.

Is it really the case that we don’t want people aiming for an annual retirement income of more than £43,000?

To put that figure into context, the PLSA Retirement Living Standards report suggests that an individual needs an annual income of £37,300 for a comfortable retirement.

Looked at another way, about £43,000 a year is the kind of retirement income that many of today’s retired generation of higher earning workers would expect to receive from their final pay and other defined benefit plans.

Schemes differ, but someone who has accrued a pension at a rate of 1/60 of their last salary over their 40-year career can retire and pay £65,000 with a pension of £43,333.

It’s not high-flying city types doing this. Among the people who manage to earn such retirement income are teachers, engineers, machinists, municipal officials and managers in various industries.

Of course, many will have reduced their pension plans in recent years – perhaps from final salary to career average – or have lost the opportunity to build more towards the end of their working lives.

But at least they’ve spent most of their careers building these excellent defined benefit plans, where their employer takes responsibility for their promised retirement income and that commitment is heavily protected.

The generation in their 20s, 30s and 40s who now work in the private sector is unlikely to get anything like this.

Instead, they receive defined contribution pensions that the employee and their employer deposit money into, investing the amount to provide a retirement pool that the individual must then convert into retirement income.

> Pensions explained: what you need to know about how they work

This leaves the younger generation of pension savers much more exposed to the vagaries of the market: long-term gains in the stock market, volatility and uncertain income are all factors that they must take into account in one way or another. Many consider themselves ill-equipped to do that.

In addition, until the announcement of the budget, they also had to deal with a lifetime pension benefit that was based not only on what they had deposited, but also on any investment growth.

And to compound the problem, instead of rising with inflation, wages or average market performance, as you would expect from such a limit, the lifetime allowance has been hacked repeatedly.

It was introduced at £1,500,000 in 2006 and by the time Labor left power it had been increased to £1,800,000.

But then successive Conservative chancellors got their hands on it and the lifetime allowance was cut repeatedly, to a low of £1 million between 2016 and 2018.

By the time it was abolished five years later, it had managed to rise to £1,073,100 by the princely sum of £73,100.

If the lifetime benefit had increased by £1,500,000 from its inception in line with RPI inflation, it would now be £2,670,000.

It is clear that the lifetime benefit is not only a poorly designed ceiling – as it includes investment growth and what is paid – but also one that you cannot trust.

Removing it may look like a stopper for older, wealthier savers, but it’s of greater help to younger workers who aim for high pay and decent retirement income, who do as they’re told and start saving early.

Someone saving £410 each month into a pension – from their own contributions and employer contributions plus tax relief – with an average annual return of 7 per cent after 40 years would have a pot of £1,076,000.

That’s enough to meet the lifetime benefit that was just scrapped.

I don’t see why you would want to bring back such a flawed system. Especially if you already have an annual allowance to prevent the highest earners from running like bandits on pension tax relief.

Labor should at least try to bring some clarity to the situation.

Would they return the lifetime allowance to the £1.07 million it was cut for, the much higher £1.8 million they left office with, or some other amount, and be indexed for inflation or investment growth?

I put that question to Rachel Reeves’ office for This is Money readers yesterday, but understandably she didn’t want to get involved in such a hot topic.

However, Labor owes it to pension savers to come up with an answer quickly.