A tax measure introduced in the 2021 Budget to reduce the cost of pension tax relief will raise twice as much for the Treasury as originally expected, according to analysis by pension consultants LCP.
Pension tax relief is currently limited by a Lifetime Allowance (LTA) which means that when pensions worth more than the LTA are accessed a special tax charge is levied on the excess amount. Where the excess is taken in the form of a regular income, the LTA charge is 25% (on top of regular income tax), whilst on lump sum withdrawals the LTA charge is 55% (though with no further tax being due).
The LTA system raises money for the government in two ways:
- Those who take pensions which take them over the LTA pay tax charges; in the latest year for which figures are available, 2020/21, £382m was paid in charges;
- Some people willl change their behaviour, perhaps saving into an ISA rather than a pension; these savings no longer qualify for ‘up front’ tax relief, giving the Treasury extra revenue now, though less tax later (as ISA returns are tax free);
In the 2021 Budget, the Chancellor announced that the Lifetime Allowance would be frozen at £1,073,100 up to and including 2025/26 instead of the previous commitment to inflation-proofing. The table below shows the expected annual yield from the change, totalling just under £1 billion over the period to 2025/26.
However, these policy costings were produced at a time when inflation was assumed to be 2% or less in each year up to 2025. In fact, inflation has been far higher than expected, which means that the freezing of the LTA ‘bites’ much more than the Treasury assumed when the policy was announced.
Although the eventual yield from the policy will not be known for several years, LCP has estimated that the higher inflation we have already seen, combined with higher inflation next year than the Treasury expected, means that the total impact of the policy just in the period that the Treasury analysed above is likely to be in excess of £2 billion rather than the £1 billion originally assumed.
Commenting, 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”.