Lifetime Pension Schemes limits frozen until 2016
The 2010/11 pension schemes lifetime allowance and annual contribution limit of £1.8 million and £255,000 are to be kept at those levels for the following five years.
Baker Tilly analysis
In an unexpected move the Chancellor has opted to freeze the annual limits and this move will restrict individuals' scope to make pension provisions that keep up with future inflation. This threatens to hit individuals who are unable to make substantial contributions in the short term due to the credit crunch and who may wish to resume funding their pensions when business conditions ease.
Freezing the lifetime allowance has the potential to create a substantial tax on growth of pension funds and may be designed to prevent erosion of the additional yield from the 45% top tax rate. This may reflect the wider concern expressed at initial introduction of the pension reform that offering too much tax incentive to the wealthy to make pensions provisions was an inappropriate use of public resources.
In detail
When the current pension scheme rules were brought into effect on A Day, 6 April 2006, the annual contribution and lifetime allowance limits were set at £1.5 million and £215,000 and they have been set to increase year by year until 2010/11.
- For 2009/10 the limits will be £1.75 million and £245,000
- For 2010/11 will be £1.8 million and £255,000 and this limit will then apply until the end of 2015/16.
Freezing the lifetime allowance for six years has potentially very serious consequences for existing schemes. The lifetime allowance puts a cap on the value of an individual's pension fund. If the lifetime allowance is frozen and funds grow, especially funds that have invested in stocks and shares when the market was at its lowest. Any resurgence in stock market values risks making pension funds over-funded and susceptible to the 55% charge on withdrawals of funds that exceed the lifetime allowance.
This change makes decisions about protection of pension funds much more critical: the deadline for opting for protection is 5 April 2009.
Six years is a very long time for the lifetime allowance to be held at the same level. The prospect of such a freeze will have a massive potential effect on individuals planning their contributions to pension schemes because, when the pension comes to be drawn, withdrawals of the excess over the lifetime allowance are taxed at 55%. Pension funds whose value is already close to the existing maximum lifetime allowance are at extreme risk of seeing their value exceed the maximum in the period between 6 April 2010 and 5 April 2016.
Holders of existing schemes that are close to the present lifetime maximum need to consider the option of protecting their funds. They can opt for 'Enhanced Protection' which ensures that no recovery charge is payable at any time if the value of the fund exceeds the lifetime limit. However, this is not a simple no-risk option and it is not available to all pension fund holders because 'Enhanced Protection' only applies to pension funds that have received no further contributions since A-Day.