If Labour’s proposed reinstatement of the lifetime allowance was to go ahead, it would be “sensible” to go beyond just reintroducing it at its previous level, according to the Institute of Fiscal Studies.
In a briefing paper looking at how the pensions lifetime allowance could be reintroduced, the IFS said there should not simply be a return to the system that existed before it was scrapped.
The think tank said to do this would be a missed opportunity at reform.
Carl Emmerson, deputy director of the IFS and co-author of the piece, said given the current way in which pensions are taxed there is a case for reintroducing a lifetime allowance.
This is mainly because many other aspects of the system are overly generous to high earners who get sizeable employer contributions and accumulate big pension pots, he said.
He added: “Rather than a simple knee jerk return to the system of two years ago, a new Labour chancellor would be well advised to implement a comprehensive and lasting reform which could rationalise, simplify and make fairer the current system of pension taxation whilst also raising revenue in the medium term.
“The danger is that a reintroduced lifetime allowance ends up being just another bump in the pensions tax road, and another missed opportunity to rationalise the system with a coherent package of measures.”
Shadow chancellor Rachel Reeves has pledged that a Labour government would reintroduce the pensions lifetime allowance, which was abolished by chancellor Jeremy Hunt in his March 2023 Budget.
The lifetime allowance was a limit on the total value an individual’s private pensions could reach before tax rates were applied.
When it was abolished the LTA stood at £1,073,000.
How should it be reintroduced?
The IFS set out several options of how it could be brought back.
The first would be to simply reinstate it at its previous level, but this would raise several questions, it stated.
Firstly, how should individuals whose pension wealth is above the reinstated lifetime allowance, perhaps as a result of contributions made following the March 2023 Budget announcement, be treated?
This was an issue when the lifetime allowance was first introduced and when it was lowered and special protections were put in place at the time, which could be done again.
Also what about those who had large uncrystallised pension pots but who have made withdrawals – or turned age 75 – since April 2024 when there was no lifetime allowance in place?
The IFS said an incoming Labour government could simply accept this, and reintroducing the lifetime allowance would raise less revenue as a result.
Alternatively, a way to ease the transitional issues would be to reinstate the lifetime allowance but at a higher level than £1,073,000.
Higher value LTA
One option set out by the IFS was to reinstate the lifetime allowance at a higher value alongside a reduction in the amount of pension from which 25 per cent can be taken tax free.
There should also be a new limit on the amount of pension that can be bequeathed free of inheritance tax.
The IFS said: “For example, a cap on the amount of pension wealth that can escape inheritance tax could be aligned with a reduced cap on the amount of pension on which a 25 per cent tax-free lump sum can be taken.
“Such a cap set at £400,000 would mean that a homeowning couple could still bequeath up to £1.8mn in total free of inheritance tax, but those with more could face an additional bill.”
It also suggested a reinstated lifetime allowance should be less generous for defined benefit pensions (compared to defined contribution pensions) than the one that was in place from 2006 to 2022.
Under previous rules, the lifetime allowance valued defined benefit pensions at 20 times the pension income that they provide (plus any tax-free lump sum).
The IFS said one option could be to reintroduce the lifetime allowance as a cap on contributions to DC pensions and accrued benefits in DB pensions, rather than on the pensions’ estimated value.
Mubin Haq, chief executive of the Abrdn Financial Fairness Trust, said: “Removing the pensions lifetime allowance was a giveaway to those with the largest pension pots; in 2021-22 only 11,000 individuals paid this charge with the average amount due being over £40,000 each. Reversing this change is right if other pension tax reliefs aren't cut back.
“Better would be to implement reforms such as reducing the maximum amount that can be taken tax-free from a pension pot and closing the loophole which allows pension pots to be passed on without payment of inheritance tax.
"These changes would weaken the case for reintroducing a lifetime allowance at the same level as it was before and could allow greater support for those with smaller pensions.”
amy.austin@ft.com
