Budget heralds significant pension changes

Prospect’s pension officer Neil Walsh outlines changes to tax relief on pension contributions and creating a secondary annuity market

The lifetime allowance is a limit on the value of benefits in your pension schemes that can be paid without triggering an extra tax charge. Effectively the lifetime allowance is a limit on the amount of pension wealth built up over a working lifetime that can benefit from tax relief.

The lifetime allowance was £1,500,000 when it was first introduced in April 2006. By April 2011 it had risen to £1,800,000. The current government reduced it to £1,500,000 from April 2012 and £1,250,000 from April 2014.

The Chancellor announced in his March 2015 Budget that the lifetime allowance would be further reduced to £1,000,000 from April 2016.

He also said that the government would increase the lifetime allowance in line with inflation (as measured by CPI) from April 2018, but this is not binding on future governments.

The reduction in the lifetime allowance will impact on a number of Prospect members. It means that the maximum pension that can be accrued in a defined benefit pension scheme is £50,000 (or about £43,500 in a typical defined benefit scheme that also offers a pension lump sum of three times the pension).

Prospect members who have long careers and have reached senior levels in the civil service, electricity supply industry, telecommunications sector or other areas that offer this form of pension provision may well exceed the lifetime allowance. For example:

• a member with 40 years’ service in a final salary pension scheme with an accrual rate of 1/80 and a lump sum of three times the pension will exceed the lifetime allowance if their final pensionable salary is about £87,000 or more
• a member with 40 years’ service in a final salary pension scheme with an accrual rate of 1/60 will exceed the lifetime allowance if their final pensionable salary is £75,000 or more
• members with longer service or members who have made additional voluntary contributions will exceed the new lifetime allowance at lower levels of pensionable earnings.

There will be transitional protection for those whose pension pots are already in excess of £1,000,000 to ensure that the reduction in the lifetime allowance does not have a retrospective effect.

It is not yet clear what form this protection will take, but it is likely to mirror arrangements put in place when the lifetime allowance was reduced to £1,250,000.

The Labour party recently announced that it would reduce the annual allowance to £1,000,000 to pay for its revised university tuition fee policy. It is therefore unlikely that a future government would reverse this decrease as it enjoys wide, cross-party support.

Further changes to different aspects of pension tax relief (such as Labour’s proposal to reduce the annual allowance to £30,000) may well feature in parties’ manifestos for the upcoming general election.

Creating a secondary annuity market

In 2014, the Chancellor unveiled major reforms to allow people entering retirement more flexibility over how they used their defined contribution pension pot by ending the requirement for some people to purchase an annuity.

In the 2015 Budget, the Chancellor announced plans to allow people who are already receiving income from an annuity to sell that income to a third party. The proceeds of the sale could be taken flexibly and would be taxed at the marginal rate of tax.

The government is suggesting that an annuity holder would need the consent of their provider to trade in their annuity on a secondary market. Guidance or financial advice is also likely to be required before taking this step.

Many people holding an annuity are likely to be better off retaining that income. Any new regime must protect vulnerable customers from making inappropriate choices in relation to one of the most valuable assets they are likely to possess.