The pension reforms that could cost you £150,000

Tax

Millions of savers will pay more in pension tax because of reforms unveiled by Jeremy Hunt in the Budget.

The Chancellor’s decision to scrap the lifetime cap on pensions from next week was heralded as a boost for retirement savers. But new analysis commissioned by The Telegraph has shown that abolishing the lifetime allowance, instead of increasing it with inflation, will cost savers with large pension pots as much as £150,000 in tax.

This is because Mr Hunt has frozen the amount that can be withdrawn from a pension tax-free as a lump sum. This used to be 25pc of the value of a saver's pot.

If the LTA had risen with inflation over the past 12 years then it would be £2.56m today, giving savers a tax-free lump sum of £640,750, according to calculations by the investment firm AJ Bell.

But when he removed the LTA, Mr Hunt also froze the tax-free lump sum at £268,275 – a quarter of the old LTA of £1.073m.

The freeze means roughly two million savers who are forecast to have pots worth £1.07m will be blocked from building up any more cash in their pension tax-free.

This will cost a higher-rate taxpayer £148,990 in tax compared to if the LTA had gone up in line with inflation and a basic rate taxpayer £74,495.

Tom Selby, of AJ Bell, said the Treasury had “given with one hand and taken away with the other” with the Budget’s pension tax reforms.

“The removal of the lifetime allowance charge should make the system simpler for savers, clearing away a disincentive to save for some, as well as a penalty for strong investment growth. However, the quid pro quo for this reform – and the increase in the annual allowance – was the decision to freeze tax-free cash entitlement at £268,275.”

John Ralfe, a pensions consultant, said: “Scrapping the LTA altogether was certainly a headline-grabber, but it doesn't do much for high earners in the private sector with defined contribution pensions, because the tax-free cash amount is frozen.”

Pension experts warned the freeze could deter higher earners from saving into their pension.

Sir Steve Webb, of pension consultancy LCP, said: “There aren’t that many people for whom saving extra into a pension would make sense if they are going to be paying 40pc tax on anything they draw out and get no tax free cash on the last slice.”

Sir Webb said the tax-free lump sum is now open to “death by inflation and future cuts”.

He added: “A future Chancellor will be very tempted to reduce it – for example to £200,000.”

Some savers will have higher tax-free lump sums due to having previously taken out protection against LTA cuts in the past.

The LTA has been changed so many times over the years that HM Revenue and Customs allowed exemptions for those who were close to or had just hit the lower limit.

Savers with pots worth over £1m as of April 2016, when the LTA was cut from £1.25m, could apply for one of two protections: “individual protection 2016”, which protected their allowance to the lower of the value of their pension savings on 5 April 2016 or £1.25m, or “fixed protection 2016” which fixed their LTA at £1.25m.

For savers who took out “fixed protection 2016”, their tax-free lump sum could be as high as £312,500.

HMRC has confirmed that even though the LTA has been scrapped, savers with protection will be able to retain their higher tax-free lump sum while still paying into their pension over the old LTA limit.

A spokesman for the Treasury said: “One of our key priorities is to cut NHS waiting lists and with lots of people awaiting treatment, we need to move quickly. That’s why we're implementing pension reforms in a matter of weeks to help keep experienced doctors and consultants in our NHS.

“Alongside thousands of NHS clinicians, the Government also expects many other experienced public servants to benefit from this change, including hundreds of serving teachers and police. Overall, the abolition of the lifetime allowance is expected to help over 10,000 public sector workers.”