Scrapping the pension Lifetime Allowance: should you react to a change in Government?

With talk that a Labour Government could backtrack on plans to abolish the Lifetime Allowance, should pension savers look to crystalise some of their pot in the coming months or stick to their existing plans?

Chancellor Jeremy Hunt’s decision to abolish the Lifetime Allowance (LTA) on pension pots came as a huge shock in last year’s Budget.

The move meant anyone whose retirement savings were more than £1,073,000 would no longer face tax charges on the excess.

This applied from April 2023, with the Government set to completely scrap the LTA from April 2024.

But what happens if Keir Starmer’s Labour party wins the upcoming General Election and carries out its pledge to reinstate the LTA?

Here, we take a look at the likelihood of the policy being reversed – and whether you can do anything to protect yourself from future taxation.

First, some background.

The Lifetime Allowance was introduced in 2006 and set a maximum amount on how much you could build up in pension savings without incurring a tax charge.

This figure was initially £1.5 million. It was then gradually increased to £1.8 million by April 2010, before being reduced back down to £1 million by April 2016.

If someone’s pensions were worth more than the Lifetime Allowance when a check was made, a charge would be due on anything over this amount.

This tax charge would be 25% of the excess if it was a regular pension, or 55% of it was a lump sum.

Responsibility for paying it would be shared between the individual and scheme administrator.

Jeremy Hunt surprised almost everyone by revealing in his March 2023 Budget that the LTA would be abolished as part of his pension reforms.

He announced that, from 6 April 2023, there would be no tax charge for exceeding the Lifetime Allowance (£1,073,000 for most people) with the policy totally scrapped from April 2024.

The shock move surpassed everyone’s expectations, according to Helen Morrissey, head of retirement analysis at Hargreaves Lansdown.

“This much-maligned rule has been a check on investment performance and its removal is extremely welcome,” she said at the time.

However, there is talk that celebrations to mark the end of the Lifetime Allowance may be premature, particularly if Labour gets into power.

A potential change in Number 10 Downing Street is making some pension savers nervous given Labour’s pledge to reverse its abolition.

Rachel Reeves, the Shadow Chancellor of the Exchequer, told the House of Commons last year that the tax burden must be shared fairly.

“That is why I have announced today that Labour will reverse the changes to tax-free pension allowances,” she said.

“It is the wrong priority, at the wrong time, for the wrong people.”

Although we’re still a long way from a General Election even being called, early polls are suggesting Labour is likely to form the next Government.

And time is certainly ticking for the Conservatives to make the required progress on various pensions-related policies, according to David Brooks, head of policy at consultancy Broadstone.

“The potential for a change in Government sometime in the next 12 months appears to be focussing minds on future pensions policy,” he said.

“If the polls are to be believed, this Government has a finite time to make significant policy developments before passing the baton to a different party.”

It’s also inaccurate to dismiss the potential reintroduction of LTA as only being an issue for the 1% of wealthiest individuals, according to a report from Lane Clark & Peacock (LCP), a consultancy.

“We find that 4-6% of those in the run-up to retirement with pension savings are potentially affected, perhaps around a quarter of a million people,” it warned.

Lifetime Allowance charges have already been a useful revenue source, according to our analysis of figures from HMRC.

The total value of all Lifetime Allowance charges since 2006 stands at a remarkable £2.58 billion, with thousands of people having exceeded the total allowed.

The highest individual year was 2021 to 2022 when 11,660 charges were reported by the scheme, at a total cost of £497 million.

The fact is that reintroducing the LTA is not as simple as “pasting back into legislation” every line which has been taken out, according to LCP’s report.

“Careful consideration would need to be given to transitional arrangements, including for those who had made savings decisions during the period in which the LTA had been abolished,” it stated.

The study also highlighted key issues that a new Government would need to consider before reintroducing the LTA.

These include:

• Whether transitional protection would be needed for those who had – in good faith – taken advantage of the LTA changes from April 2024 to build up pension savings beyond the level.
• Could everyone start under a reintroduced LTA regime from zero – or would the Government try to estimate how much of the LTA people might have used as a baseline?
• Would there need to be ‘anti-forestalling’ legislation introduced to avoid a rush of people crystallising their pensions to avoid a new LTA charge?

“Whilst reinstating the LTA is no doubt attractive from the perspective of political messaging, the practicalities and risks associated with doing so would appear to be daunting,” it concluded.

So, how should people react?

Do they just keep their fingers crossed that the Lifetime Allowance won’t be reinstated, or do they need to crystallise some of their pension pot now?

The overwhelming opinion of industry observers we interviewed was to carry on saving without becoming overly concerned about a change of Government.

Pension rules are extremely complicated and trying to predict the future is a dangerous game, according to Tom Selby, AJ Bell’s director of public policy.

“Generally speaking, it is best to deal with tax rules as they stand, rather than try to make decisions based on guesswork over future changes,” he said.

“Labour have signalled their intent, but that is no guarantee they’d pursue such a policy in power.”

Mr Selby believes resurrecting the Lifetime Allowance would be “controversial, highly complex and create a host of secondary problems” for a new Government. 

“That doesn’t necessarily mean it a good idea to jump to a decision now in an effort to pre-empt a future change in pension tax rules,” he added.

“There are consequences to crystallising your pot now. For example, if left uncrystallised, your tax-free cash entitlement could continue growing up to the £268,275 maximum.”

Pete Matthew, the founder of Meaningful Money, agreed.

“You can do more harm by jumping the gun,” he said. “I’d never say to stop paying in to a pension.”

There’s also a precedent in place that allows people to protect themselves from a new LTA, according to Jason Hollands, managing director of Bestinvest.

“When the LTA was first introduced by Labour, those in excess of it could apply for protection, which is an agreement to cease further funding and avoid penalties,” he explained. 

There is also no reason why Labour would remain hardwired to the magic number of £1.073 million, which it ended up at under the Conservatives.

In fact, when Labour first introduced the LTA, it was a much higher amount of £1.5 million and had increased five times to £1.8m by the time the party left office in May 2010,

“Labour may have created the LTA, but the decimation of the allowance prior to its abolition was the handiwork of former Tory Chancellor George Osborne,” he added.

“Had it been adjusted by inflation from the level it was under the last Labour Government (£1.8 million), it would now be over £2.23 million.”

However, Hollands does think those with more money to put aside could consider increasing the amounts they put into retirement funding.

“Those with large pensions do have a potentially short window to recommence making contributions while the LTA does not exist in law,” he added.

According to Alice Guy, head of pensions and savings at interactive investor, it’s important to remember that pension saving and planning for retirement is a long-term game.

“Over time, it pays to keep focused on that ultimate goal and keep calm and carry on building wealth,” she said.

“If you’ve built up pension wealth and you’re not sure about how any possible Lifetime Allowance changes could impact you, then consider getting financial advice to help you make decisions for the future.” 

This article does not constitute financial advice. If you are considering making changes to your pension you should consider getting financial advice.