As a rule, things in life are interesting or not, important or not. Most things in financial services are neither interesting nor important. Bucking this trend is the Lifetime Allowance (LA). If you think the LA is interesting you need to get out more. It is, however, important.
Planning around the LA is ridiculously complicated. The rules were drafted for money purchase plebs by final salary swanks in the Civil Service. One would be hard pressed to deliberately design a system more likely to entrap the unwary.
It did not (does not?) need to be this way. Imagine a world where the LA is based on input, not output. Where an individual is given an allowance that caps what they can pay into pensions, not what they take out.
By example, take Performance Pam. Over her life she has paid in £200,000 to pensions. Her fund value is £1.25M. She has taken on risk and been rewarded. Too well. Now she cannot pay any more money into her pension fund.
Cautious Colin, on the other hand, has the same size of pension fund but has paid in £600,000 to achieve this.
Both are higher rate taxpayers. Performance Pam has received £80,000 of tax relief, compared to £240,000 for Cautious Colin. How on earth does that make sense? A system designed to limit tax relief for the “rich” gives three times as much to one person over the other. As an aside, it also effectively subsidises those who choose the easier investment ride.
Contrast with a Lifetime Allowance based not on what you take out but on what you put in. Let us use a figure for this of £600,000 (convenient, eh?). Performance Pam contributes the full LA of £600,000 into her pension over her lifetime. She now has a fund of £3.75M. Cautious Colin does the same and has his £1.25M pension fund.
Some of the pros of this approach:
The Whitehall boffins would know exactly what their maximum tax-relief costs would be. So perhaps they could plan for the future a little better. (I know, I know..)
HMRC will actually collect more tax: Performance Pam’s fund will produce a higher taxable income. Or HMRC will cream off 55% of a much bigger pot when she dies. Either way, more dosh for the State. If you are going to squeeze the “rich”, do it properly.
Easy to understand. “Have you used up your LA?” “Yes.” Then you cannot pay any more in.” Simple. If the Government subsequently raise the LA our fictional friends simply write out a cheque to their pension providers for the difference. No reference to fund sizes, multiplying your inside leg measurement by 20 (or is it 25?), making assumptions about contributions, investment returns and all the other crud.
Perhaps the current rules were designed to ensure benefits could not be broadly more than a high ranking Civil Service pension. If so, that is a reason, not a justification. It ain’t good enough.
Is there is a gaping flaw in a Lifetime Allowance based on what you pay in rather than what you take out? It seems to offers numerous upsides and no downsides. So it will never happen, obviously.