The government has capped the maximum anyone can save tax efficiently in a pension at £1 million. It sounds like an awful lot of money - and therefore nothing that we need to worry about. However, a new report has revealed that a £1 million pot could leave savers with an income of just £21,000 in retirement. Public sector workers with final salary pensions, meanwhile, will be sitting pretty on up to £50,000 a year.
The report, by Royal London calculated what someone would be left with if they built up the government maximum of £1 million in a defined contribution scheme. If they used that pot to buy an annuity offering a guaranteed income, linked to inflation and providing a pension for their spouse worth two thirds of the full pension after their death, it would mean a pension income of just £21,000 a year. It contrasted this with the rules surrounding defined benefit schemes - which allow people to retire on as much as £50,000 tax efficiently.
The rules have been changed continually over the years. The lifetime cap was only introduced in 2006, at which point it was set at £1.5 million. Any sums over this level were then taxed at 55%. It was designed to increase every year, and did so until 2010, when it reached £1.8 million, and the cuts began. It was cut in 2012 and 2014, and then in April this year, the government reduced it yet again to £1 million.
Former pensions minister Steve Webb, who is now director of policy at insurer Royal London, said the situation was a 'scandal', and warned the if the government is tempted to tinker even further with the rules, it will make the situation even tougher for savers. He added: "Saving for a pension should be a long-term business, and constant tinkering with tax limits in pursuit of short-term revenue by the Government gains creates uncertainty for savers and makes saving in a pension a less attractive option."
Tom McPhail, head of retirement policy at Hargreaves Lansdown, has been urging the government to scrap the lifetime allowance, as part of a broader simplification of the existing system. He says: "Investors want a simple savings system which helps and rewards those who want to do the right thing. There are generous incentives available from the government but the rules are riddled with complexity and inconsistencies. Our proposals would mean a fairer system with more efficiently targeted incentives, which would help to engage younger workers with retirement saving."
Should you be worried?
At the moment, most savers don't have to worry about the lifetime cap, and there's nothing they need to do beyond saving as much as they can afford for retirement. The vast majority of people will not get anywhere near the £1 million limit at the moment.
For those who do reach the limit, if they stop there, and choose not to link to inflation or leave a pension for their spouse, they can get an annual pension of £45,400, which is the kind of pension income most people can only dream of.
The problems will come if the lifetime allowance is cut further, or if it doesn't increase with inflation over the years, which the government has shown an appetite for. If this happens, more and more people will find themselves crushed by the allowance, and unable to save enough to secure a decent pension for themselves and their other half.
The experts are urging the government to avoid this potential disaster, but given the saving the Treasury can make by slashing tax incentives for pensions, they may find it too tempting to resist.
It means that if you have a large pension pot, or you think you will have by the time you come to retire, it's worth taking precautions, and contacting an advisor sooner rather than later. There is something known as 'transitional protection', which is introduced each time the lifetime allowance changes - which allows people to protect them sums they have built up from tax further down the line. The rules have become increasingly complex, so it's worth involving a professional but you can take steps to avoid breaching the cap and paying tax at 55%.