Budget 2015: The reduction of the lifetime allowance to £1m will hit defined contribution savers hardest say experts, who anticipate a rise in members exiting pension saving.
On Wednesday, George Osborne announced a 20 per cent cut to the lifetime allowance for pension savings, bringing it to £1m from £1.25m.
In his Budget speech, the chancellor said the reduction would target current unsustainable levels of tax relief and would provide the government with annual savings of £600m. This is Osborne’s third cut to LTA during his tenure, which has steadily been trimmed from £1.8m during the coalition's term.
However, from 2018, the £1m allowance will be indexed in line with the consumer price index for the first time, to help protect savings from inflation.
DC hit hardest
The impact of the new £1m limit will vary between defined benefit and DC savings.
Chris Noon, partner at consultancy Hymans Robertson, said the cut was too blunt an instrument and would disproportionately impact defined contribution savers.
What you’ve just said is, it doesn’t matter how hard you save or how much investment risk you’re prepared to take… the biggest index-linked pension we’re going to allow you to have is roughly £30,000 a year
Philip Smith, PwC
“For DB people it’s not that bad; the government use a 20-to-one conversion factor which gives a pension of £50,000 – it’s a pretty high pension. You’d have to have a salary of £80k-£100k to be hit by the lifetime allowance,” he said.
Noon added that £1m for a DC member would generate a pension income of around £30,000.
Philip Smith, head of defined contribution pensions at consultancy PwC, said to produce a DB-level pension from a defined contribution pot would require considerably more than £1m and the current mismatch in values was a legacy of outdated regulations.
“Years ago a factor to 20 might have been the correct way to value a DB pension but in the current market it’s just not,” he said.
He said the reduced £1m limit put a cap on aspiration and people’s ability to save.
“What you’ve just said is, it doesn’t matter how hard you save or how much investment risk you’re prepared to take… the biggest index-linked pension we’re going to allow you to have is roughly £30,000 a year,” he said.
The announcement could have a knock-on effect on the volume of transfer requests from DB members going into next month’s freedoms, Smith added.
He said members who had previously considered exercising their pension freedoms and transferring their DB pension may well find themselves much closer to the lifetime allowance in DC because of the current mismatch in the way they are valued.
Member communication
Schemes and employers will need to communicate to members how the reduction may impact their savings or plans.
This is Osborne’s third cut to LTA during his tenure, which has steadily been trimmed from £1.8m during the coalition's term.
Noon said the government’s previous cuts had created “a well-trodden path” for schemes to communicate the impact of the changes to members and make the necessary changes to benefit statements, modellers and other administrative systems.
Jackie Holmes, senior consultant at Towers Watson, said further detail was needed to gauge the impact of transitional protections and, from 2018, indexation.
“The devil is in the detail, as usual, to see what protections are in place and how that indexation is going to work,” said Holmes.
Adrian Walker, retirement planning manager at Old Mutual Wealth, said schemes would need to provide valuation projection tools for members to enable them to gauge how current saving patterns would play out in the longer term.
“[Schemes] need to enable people to play around with different things including timelines and future investment performance,” said Walker.
Walker also urged employers to think carefully about their policy for employees whose savings may be approach or exceed the LTA and to consider what flexible alternatives they might offer.
