During the budget, chancellor Jeremy Hunt scrapped the Lifetime Allowance in a bid to get Britons working longer. The lifetime allowance is set by the Government and limits the total amount people can build up in pension benefits over their lifetime while still enjoying the full tax benefits.
His decision has been criticized as “bizarre” by the UK’s leading economics research institute, which says it creates an unjustified extra inheritance tax loophole for high earners that should be closed as soon as possible.
The Institute for Fiscal Studies (IFS) stated that following last week’s budget, many people on high incomes will now be able to expand their pension pots in order to pass on hundreds of thousands of pounds more to their loved ones, tax-free, when they die.
The IFS says the purpose of pension savings should be to fund retirement incomes not to escape tax.
Isaac Delestre, research economist at the IFS, said: “Whatever you think of inheritance tax, a situation where the tax system treats pensions more favourably as an inheritance vehicle than as a means of providing income in retirement is bizarre. Abolishing the lifetime allowance has definite upsides but it will also open the door to larger pension pots being passed on tax-free at death.
“A wealthy individual dying with £2million in their pension – not implausible under the new rules – could reduce their inheritance tax bill by as much as £370,000 compared to a world where only £1.07million of their wealth is in a pension.”
READ MORE: Bank offers competitive 4.40 percent interest rate on fixed savings account
The lifetime allowance is currently £1,073,100. If someone went over their allowance, they would generally pay a tax charge on the excess. Britons pay an excess when they take a lump sum or income from their pension pot, transfer overseas, or reach age 75 with unused pension benefits.
For example, if your pension pot totals £1,200,000 then the excess is £126,900. This amount is then taxed at either 55 percent (if you take it as a lump sum) or 25 percent if you take it any other way (e.g. through drawdown, UFPLS or buying an annuity). So their additional tax bill would be either £69,795 or £31,725.
The limit applied to all personal and workplace pensions but excluded the state pension, and was due to be frozen at its current level until 2026.
Instead of increasing the allowance, as had been expected, the chancellor scrapped it altogether. Mr Hunt also increased the pensions annual tax-free allowance by 50 percent from £40,000 to £60,000.
Martin Lewis points out pension change which Hunt ‘didn’t say’ [INSIGHT]
Over two million carers missing out on savings up to £2,262 each year [LATEST]
Lloyds Bank issues warning on fraud tactic losing grandparents £1,610 [WARNING]
The chancellor said the move would encourage NHS doctors, consultants and other high-earners to remain in the workforce for longer.
He said: “I have listened to the concerns of many senior NHS clinicians who say unpredictable pension tax charges are making them leave the NHS just when they are needed most.
“The NHS is our biggest employer, and we will shortly publish the long-term workforce plan I promised in the Autumn Statement. But ahead of that I do not want any doctor to retire early because of the way pension taxes work.”
He added: “As chancellor, I have realised the issue goes wider than doctors. No one should be pushed out of the workforce for tax reasons. So today I will increase the pensions’ annual tax-free allowance by 50 percent from £40,000 to £60,000.
“Some have also asked me to increase the lifetime allowance from its £1 million limit. But I have decided not to do that. Instead I will go further and abolish the lifetime allowance altogether.”
Mr Hunt said the changes would “stop over 80 percent of NHS doctors from receiving a tax charge” and incentivise “our most experienced and productive workers to stay in work for longer”.
The changes will affect those who pay more than £40,000 into their pension annually or have saved more than £1.07million in their lifetime. Only 8,000 people across the UK have saved more than £1million in their lifetime. Just one percent of workers, meanwhile, save more than £40,000 per year, according to Government figures.