Read the full policy paper - Time to end the 'Salami slicing' of pensions tax relief.
Twice a year, in the run up to the Spring Budget and the Autumn Statement, we face a torrent of speculation as to what changes the Chancellor might make to pension tax relief.
Although pensions should surely be a long-term business, the constant tinkering with the rules around tax relief make long-term planning increasingly challenging. The Lifetime Allowance (LTA) has been cut three times in the last five years whilst the Annual Allowance has been reduced and subjected to a 'tapering' system of mind-numbing complexity.
Although each change can be justified in isolation, the combined effect of this repeated 'salami-slicing' is a huge cut in the kind of pensions that can now be bought without breaching tax relief limits.
To get a sense of the scale of these changes, we have published a new Royal London Policy Paper – ‘Pensions Tax Relief – Time to Stop the Salami Slicing’. In it we look at the combined effect of the falling LTA and the falling annuity rates that we have seen over the last decade.
The report shows that a pension pot worth the current maximum of one million pounds could buy an annuity of around £45,000 at age 65. This a fall of around two thirds in the last decade as falling tax limits and falling annuity rates combine to cut the pension you can buy. This is a huge restriction on the standard of living that people can secure through pension saving.
Indeed, for those who want a 'gold standard' annuity with full RPI protection, a good pension for a surviving spouse and guarantees in the early years, they would struggle to get a starting pension of much more than £21,000 without breaching tax relief limits.
Of course, not many people would take a £1 million pension pot and use it to buy an annuity. But the factors that have led to falling annuity rates – principally increasingly longevity and lower interest rates – also mean that the standard of living available from a £1 million pot invested in drawdown has also fallen considerably.
Our view is that the LTA should ideally be scrapped altogether. It would be one thing to argue for a sensible (and simple) annual limit on the amount of tax relieved contributions you can put in to a pension, but it is very hard to see why there should be a limit on the total amount you can build up in a pension pot.
The very fact that nearly 100,000 people have now applied for one the various forms of individual or fixed protection available to those affected by these changes shows that this is no longer an issue just for the super-rich. And if the planned policy of linking the LTA only to CPI inflation from 2018 onwards goes ahead then more and more people will be at risk of exceeding the LTA.
If the LTA cannot be abolished entirely (which is probably unlikely in the present climate) we should hope that the Chancellor will resist the temptation to go for further 'salami slicing' of tax relief in his Autumn Statement.
The best thing he could do would be to stand up in Parliament and announce that he is keeping his party's pre-election pledge to make no further changes to pension tax relief during the lifetime of this Parliament.
If he did so, we could all get on with the day job of designing and delivering high quality pensions and helping clients to make the best choices, rather than having to respond to the latest short-term change to the pension tax relief regime.
Director of Policy and External Communications
Steve Webb is now Director of Policy and External Communications at Royal London. Before this he was Minister of State for Pensions between 2010 and 2015, the longest-serving holder of the post. During that time he implemented major reforms to the state pension system, oversaw the successful introduction of auto enrolment and played a key role in the new pension freedoms implemented in April 2015.