Lifetime Allowance in the age of inflation

GUIDE 1 OF 6

Since the end of the global financial crisis, the UK Government has encouraged people to save into private pension arrangements, lowering their reliance on state-funded provision. However, private pensions are not immune to taxation and a key metric, the Lifetime Allowance (LTA), has been frozen since April 2021.

Whilst there is no limit to the amount one can save into a pension, an additional tax charge is due on pension savings that exceed the LTA. The current LTA stands at £1,073,100. The charge and taxation surrounding the allowance can be quite complex; this will be discussed in our next guide.

Historically (from the 2018/19 tax year), the LTA increased annually by the rate of inflation, as measured by the Consumer Price Index (CPI). However two changes have made LTA planning a more immediate issue for UK savers:

  1. The UK government took the decision to freeze the LTA until at least 2025/26 (following the onset of the Coronavirus pandemic). This means that any capital appreciation of a pension fund, for those at or above their LTA, will increase their LTA charge.
  1. As the global economy has started to re-open, supply chains have struggled and bottlenecks have emerged. Combined with the war in Ukraine, this has exacerbated pre-existing price pressures, resulting in significantly higher inflation than past decades.

In this chart, we compare the growth from the MSCI World Equity Index (A) to the rise in UK inflation (B) during the period the LTA increased with inflation (2018/19 – 2020/21). There has been significant equity outperformance over this period. The LTA uplift, while welcome, has only provided a small level of protection and an increasing number of savers are seeing their pension values exceed the LTA.

The Inflation rate in those years was 3% in 2018/19, 2.4% in 2019/20 and 1.7% in 2020/21. From the 2021/22 tax year, the LTA was frozen. Even if indexation offers only partial protection, with the Bank of England forecasting UK inflation of 10% by the years end, the four-year freeze on the LTA will see a material decline in the real (inflation adjusted) value of the pension limit. As a result, more and more pension funds could be subject to the LTA charge.

Whilst it is impossible to predict the future level of inflation, it seems clear that the current elevated level will take time to subside. With the LTA level frozen for 4 years, it is thus highly likely that UK CPI will continue to erode the real value of the LTA cap.

Given these factors, many clients are now reviewing the LTA aspects of their pension arrangements. Bentley Reid has therefore created this set of guides to inform this process.

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