Treasury may double its take from LTA freeze
A tax measure introduced in the 2021 Budget to reduce the cost of pension tax relief for the government will raise twice as much for the Treasury as originally expected, new analysis suggests.
Pension experts say the tax windfall for the Treasury is because inflation assumptions have proved wide of the mark.
Pension consultants LCP analysed costings produced for the 2021 Budget, when then Chancellor Rishi Sunak announced that the Lifetime Allowance would be frozen at £1,073,100 to 2025/26, instead of the previous commitment to inflation-proofing.
For the costings, inflation was assumed to be 2% or less in each year up to 2025. That led to a conclusion that the expected annual yield from the change would be just under £1bn.
In fact, inflation has been far higher than expected, topping 10% recently. As a result the freezing of the LTA will bite much more than the Treasury assumed when the policy was announced, LCP said.
Although the eventual yield from the policy will not be known for several years, LCP estimated that the higher inflation already seen combined with higher inflation next year, will mean the total impact of the policy is likely to be more than £2bn rather than the £1bn originally assumed.
Mike Richardson, partner at LCP, 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.”
He said that 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.
Pension tax relief is currently limited by a Lifetime Allowance (LTA) which means that when pension pots exceed the LTA and are then accessed a special tax charge is levied on the excess amount.
Where the excess is taken in the form of a regular income, the LTA charge is 25% (on top of regular income tax), while on lump sum withdrawals the LTA charge is 55% (though with no further tax being due).
The LTA system raises money for the government in two ways, LCP explained:
• Those who take pensions which take them over the LTA pay tax charges; in the latest year for which figures are available, 2020/21, £382m was paid in charges;
• Some people will change their behaviour, perhaps saving into an ISA rather than a pension; these savings no longer qualify for ‘up front’ tax relief, giving the Treasury extra revenue now, though less tax later (as ISA returns are tax free).