Pension: Expert explains what a lifetime allowance is
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Pensions can be important for those who are planning towards retirement as a key source of income. However, the pension a person receives may vary depending on their line of work, or how they choose to save. There are two main types of private pension which are worth considering for retirement planners.
The first is a Defined Contribution (DC) pension, which is based on how much is paid in.
Next is a Defined Benefit (DB) pension, which is usually a workplace pension based on a salary and how long a person has worked for their employer.
Now, a pension “quirk” has been revealed which could mean defined benefit members have an income some 76 percent higher than an equivalent defined contribution saver.
This is the income a person can generate all before breaching the Lifetime Allowance – the limit on the amount of pension a person can take from their pot before triggering a tax charge.
However, many may be wondering why this kind of disparity exists in the first place.
AJ Bell, an online investment platform service, has highlighted the reason why this difference may occur.
It has stated HM Revenue and Customs (HMRC) is currently using an out-of-date “multiplier” tool to turn a guaranteed DB income into a notional fund value to test against the Lifetime Allowance.
The organisation has estimated someone in a DB scheme could have a guaranteed, inflation-protected income which is worth £53,655 – all without breaching the Lifetime Allowance.
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In contrast, however, a 66-year-old saver through DC could buy an equivalent income from an insurance company with a £1,073,100 pot worth £30,418.
Tom Selby, senior analyst at AJ Bell, offered further insight into the matter.
He said: “While it is common knowledge that workplace defined contribution (DC) pensions are often the poor relation to generous defined benefit (DB) schemes, there is a lesser known tax quirk which creates a huge disparity in the maximum retirement income someone can generate without breaching the lifetime allowance.
“On a conservative estimate, this quirk means defined benefit members can enjoy a 76 percent higher retirement income than their defined contribution counterparts without being hit with a lifetime allowance charge.
“This is because the ‘multiplier’ used to convert a DB income into a notional fund to test it against the lifetime allowance is woefully out of date, having been introduced in the mid-2000s when annuity rates were much more generous than they are today.
“This disparity was hard to justify during normal times but as the country prepares to end lockdown restrictions and with the Government facing huge fiscal challenges as a result of the pandemic, it now seems ripe for review.
“However, addressing what looks like an anomaly would likely create a huge row with the public sector – including doctors who have worked on the frontline during the pandemic.”
There are no current plans to scrap the Lifetime Allowance, and therefore Mr Selby suggested the multiplier could be updated to “better reflect current annuity rates”.
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But there is also a suggestion the idea of tax relief costs could be rethought to create a single annual allowance for DC and a single lifetime allowance for DB.
It is hoped such a change could remove perceived unfairness within the pension system.
Express.co.uk has contacted HMRC for comment on its processes.
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