Fears grow over ‘nightmare’ 55% pensions tax – may hit more savers

Martin Lewis lays out the two types of pensions

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A brutal and badly planned pensions tax that swallows 55 percent of people’s retirement savings is set to wreak even more havoc as Chancellor Kwasi Kwarteng no longer has the political capital to scrap it.

This little-known tax on pensions is arguably the most punitive in the UK, and more will get caught as the level at which people pay has been slashed over the last decade, then frozen for five years.

There were hopes the Chancellor Kwasi Kwarteng could resolve the mess, but they may now be dashed.

The pensions lifetime allowance, or LTA, caps the maximum you can save across all your company and personal pension schemes during your lifetime.

Savings above this arbitrary level will incur an astonishing 55 percent tax. This is brutal and punishes people for doing exactly what the government wants them to do, which is to save for their final years and ease the burden on the state.

As the LTA is frozen, inflation is dragging more pension savers into HMRC’s tax net.

Before his recent disastrous mini-Budget, Kwarteng was rumoured to be planning a shake up of the pensions lifetime allowance.

He probably dare not touch it now, as he would be accused of helping the better off again.

This will leave a system in place that experts have described as “brutal, unfair, cruel and punitive”, because of the way it works.

A decade ago, the pensions lifetime allowance stood at a whopping £1.8 million, so only the wealthy were ever likely to pay it.

It has been repeatedly slashed to today’s level of £1,073,100, and now frozen until the 2025/26 tax year.

Jenny Holt, managing director for customer savings and investments at Standard Life, said: “Since then inflation has spiralled to double digits meaning that the real value of what people can save in their pension without incurring tax charges has fallen significantly.”

Holt said that while £1.073m represents a substantial pension pot, the freeze means middle and higher earners who have saved diligently can be caught out, often because their investments have done well.

“The real value of what they’re able to save tax efficiently is being cut.”

She would like to see the freeze scrapped and the LTA rise each year in line with inflation.

Aegon pensions director Steven Cameron also backed a review, saying the freeze is causing “real and long-term damage to the UK pension system and the retirement livelihoods of thousands”.

Tom Selby, head of retirement policy at AJ Bell, called on the Treasury to “finally” review the impact the lifetime allowance is having both on UK savers and the wider economy. “The Treasury should assess all pension tax allowances, with the aim of simplifying the system and encouraging more people to save for retirement.”

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The LTA is also at the heart of the current NHS crisis, Selby added. “It has forced thousands of staff to retire early or risk being hit with a punitive tax bill for breaching the allowance.”

It also hurts those in both company and personal defined contribution schemes, where contributions are invested in the stock market to grow. “It punishes those who take investment risks and enjoy long-term growth as a result.

“This runs counter to this Government’s clearly stated focus on boosting economic growth.”

The LTA is also incredibly complicated people often do not realise they will pay it until it’s too late, Selby warned. “It makes pension tax rules unnecessarily complicated, adding to an already confusing picture.”

If the Government wants people to save more for retirement, it needs to make the rules as simple as possible, Selby added.

He said the simplest solution is to scrap the allowance altogether, while controlling the amount of people can pay into a pension each year, instead.

This would prevent accusations of helping the rich. “It would also help the Government make good on its aim to simplify the tax system,” Selby added.

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