When then-chancellor Rishi Sunak froze several personal allowances in his budget in March 2021, nobody could have foreseen a double-digit inflation level not seen in decades.
While the UK government has shown no sign to reverse the freezing of the thresholds before the 2025-26 deadline set out by Sunak a year and a half ago, this is having significant impact on pensions savers.
Advisory firm LCP said that, when the measure came into force, inflation was projected to be at around 2% or less in each year up to 2025. Clearly this has not been the case, with inflation having already surpassed the 10% mark this year.
But one of the thresholds that seem to be biting consumers the most is the lifetime allowance (LTA) – the limit under which savers can get tax relief on their pension savings.
Despite being slashed budget after budget after budget, Sunak froze the threshold at £1,073,100 ($1,268,533, €1,225,319) until the 2025-26 financial year, included.
This means that anyone exceeding the limit will face a tax charge on the excess sum, which usually is 25% on the excess taken as regular income (on top of income tax) or 55% for lump sum withdrawals.
In March 2021, the freezing of the LTA was forecast to raise around £1bn for the Treasury. But since the threshold was not inflation-proofed, the Treasury could bag as much as £2bn over the period when the allowance remains frozen, calculations by LCP show.
‘Punishment’
Mike Richardson, partner at LCP, said: “Freezing tax thresholds is a highly unpredictable way of raising revenue for the government. When there is a surge in inflation of the sort we have seen recently, freezes on tax allowances can generate far more revenue than expected.
“As well as creating unpredictability for the government in terms of revenues, long-term freezes and changes in policy also make it very hard for individuals to make long-term plans for their pensions and savings”.
Ian Pickford, partner at Mazars, added: “Thousands of people have been dragged into paying additional tax on their pension savings in the last decade. With the LTA threshold on ice, this upward trend won’t slow down, hitting both defined benefit (DB) and defined contribution (DC) pension savers, especially those with generous pension perks. It’s closer than many people think.
“Freezing the cap is effectively a punishment on saving into a pension, the very thing people are encouraged to do. And the reality is that a £1m pension pot won’t go as far as many believe. Outgoings, like care costs or supporting children or grandchildren, have the potential to swallow up a large chunk of this, even just a short time into later life.
“This is why planning ahead is so crucial. Firstly, to know if you are on track to breach the LTA and secondly, to weigh up the benefits of continuing to contribute to a pension against other ways of saving for later life. Increasingly, we are seeing people turn their backs on pensions as a means of income provision in later life, opting to use them as a way to pass down wealth.
“All the time your money is in a pension, it is growing free of income and capital gains tax and for those lucky enough to have built up other savings, it’s likely a pension will be the last pot to access.”
