Pension savers to be hit with ‘double’ tax hit with lifetime allowance freeze as inflation | Personal Finance | Finance
This is primarily due to the freeze on the pensions Lifetime Allowance limit which was introduced in 2021. The tax policy was implemented as part of last year’s Budget in an attempt to reduce the cost of pension tax relief. With rumours the freeze will be extended with this week’s Budget, new analysis shows the Government is going to raise double the amount than expected from the tax policy.
For taxpayers, the lifetime allowance is the limit on how much someone can build up in pension benefits over their life while still accessing full tax benefits.
Anyone who goes over the allowance will have to pay a tax charge on the excess at certain times.
Currently, the lifetime allowance for the majority of Britons is £1,073,100 in the tax year 2022/23.
Following last year’s Budget announcement, it has been frozen at this level until the 2025/26 tax year.
When the freeze was initially introduced, the country’s Consumer Price Index (CPI) rate of inflation was at around two percent.
Government costs for the policy were assumed to be around this figure or less every year until 2025.
However, inflation has recently returned to a 40-year high of 10.1 percent with the Government forecast to generate more from taxpayers’ money than expected.
Research carried out by LCP suggests that the amount generated will be in excess of £2billion rather than the £1billion estimated originally by the Treasury.
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Mike Richardson, partner at LCP, broke down how pension savers will likely be hit if inflation continues on the trajectory it is on.
Mr Richardson 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.”
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The Lifetime Allowance is applied to the total of all the pensions someone has, including any defined benefit schemes or any savings they have in defined contribution pensions.
It should be noted that no charges are not applicable to the amount someone earns through their state pension.
Currently, the Lifetime Allowance charge is 25 percent, on top of regular income tax, when the excess is taken in the form of regular income.
For any lump sum withdrawals, the Lifetime Allowance charge comes to 55 percent for those affected.
Using this system, the Government was able to raise £382million was paid in charges for the last tax year.
On top of this, if taxpayers choose to save into an ISA rather than a pension, any savings no longer qualify for ‘up front’ tax relief.
As a result, the Treasury is able to generate extra revenue now but will miss out on more tax later.
Potential changes to the Lifetime Allowance or confirmation of a prolonged freeze will likely be announced during Chancellor Jeremy Hunt’s fiscal statement on November 17, 2022.
