The lifetime limit is worse than the 1989 regime
What’s brought this little rant on, got my goat, so to speak, is this implicit idea with this new Lifetime Limit approach that we’ve got nothing really to moan about because it’s just another way of applying the Post-1989 tax regime that already affects millions of people anyway. Well, I don’t think it is the same at all. In my view it’s much worse, but in a way that’s hard for all but the initiated insiders and pension nerds to spot, and I don’t like that at all.
Money-Purchase occupational pension schemes (otherwise known as Defined-Contribution schemes since we all became American recently) are a good example of what I mean. Bare with me as I go through my own version of fuzzy logic as I try to get my point across. It’s clear to me, and hopefully you’ll see what I mean too.
The Lifetime Limit looks like it will be set at £1.4 million. That has been ‘calculated’ by the Government types so as to ‘equate’ to the amount of money a 60 year-old male would need to purchase the ‘same’ annual annuity that a Post-1989 pension scheme would produce for a person with full service and subject to the so-called Earnings Cap. This all goes something like this:
1. The Earnings Cap that applies to Post-1989 scheme members is about £100,000.
2. Someone entitled to forty sixtieths of the Earnings Cap would get a maximum pension of something like £66,000 a year.
3. A Lifetime Limit of £1.4 million according to the original consultation which is 'broadly equivalent to a maximum pension at the date of implementation under the current occupational pension rules for a man age 60 drawing an indexed pension and providing a surviving spouse's pension' which should be a sufficient amount of money for a man of 60 to buy an annual annuity of £66,000.
4. Therefore there is no difference between what we’ve got already and what the Government is now proposing.
Now, all of this only stacks up if you don’t really understand the existing pension rights we have, so I think we have to keep our eyes wide open here. Listen.
Quite apart from the fact that the annuity rate assumed by the Government guys is plainly wrong and that you can’t buy an annuity anything like as high as £66,000 a year for £1.4 million these days (not at age 60 anyway). There is a bigger baby being thrown out with the bath water here. The problem that bothers me would still be there even if the representations that have been made to get the limit increased, say to £1.8 million, turn out to have been successful. My point is all to do with the way people in Money-Purchase schemes are treated by the current system if they accrue more in their funds than the Inland Revenue maximum benefit limits allow.
Think of someone currently in an Executive Pension Plan (an EPP) or a Small Self-Administered Scheme (a SSAS) approved under the Post-1989 (earnings capped) legislation. These are both Money-Purchase occupational pension schemes approved under Chapter 1 of the 1988 legislation (ICTA 1988). Even though they are Money-Purchase schemes, benefit limits still apply to each member depending on when they joined their employer's scheme to ensure they don’t get too much pension if their investments perform too well. So, someone in an EPP or a SSAS today who has full service rights will still be subject to the overall limit of two-thirds of final salary as the maximum pension allowed by today’s rules.
In practice, though, if their Money-Purchase investments do well, and their fund can provide more than simply two-thirds of the Earnings Cap, (the maximum pensionable salary allowable to a Post-1989 scheme member), then they are allowed to ‘buy’ additional pension benefits up to the absolute maximum the Revenue will currently allow. One option is to purchase an annuity that is guaranteed to be in payment for ten years, rather than the ‘usual’ five years. This is an expensive additional benefit and can use up a fair amount of any so-called ‘excess’ funds. Another option is to provide a contingent spouse’s pension (commonly still called a widow’s pension by us Luddites) of two-thirds the value of the member’s pension, again rather than the more common fraction of a half. This too is a very expensive add-on, and can soak up a good deal of the excess funds available. And, if you really want a Rolls Royce approach, the current rules allow you to provide annual increases to both your pension and the pension for your dependant. You could build in an increase of 5% p.a., an extremely expensive option, and one that will cost a great deal to provide. In this way, people in Money-Purchase schemes and currently subject to the Earnings Cap can still utilise quite large fund amounts to provide pension benefits at retirement. And that’s the point I’m making.
This ‘simple’ approach of giving us all a Lifetime Limit on the amount we can spend on our pensions ignores all this. What we’ll have if the £1.4 million limit goes through will be barely enough for us to buy a bog-standard pension of two-thirds of the current Earnings Cap, let alone all the frills and expensive add-ons the current legislation allows us. That’s what gets my goat, that and the fact that nobody seems to understand anything about pensions. A Lifetime Limit set at just £1.4 million means that the maximum pension benefits we will be allowed in the future will be much, much less than are currently provided by the Post-1989 legislation. That’s OK, I suppose, if that’s what Government wants to do, it’s up to them. But we mustn’t let ourselves be fooled into thinking that what we’re about to get is broadly equivalent to what we’ve currently got. It isn’t. It’s nowhere near as good. The Lifetime Limit would need to be set a hell of a lot higher than a measly £1.4 million if Government really want us to be left in the same position we are in today. If you don’t believe me, just apply for an annuity quote for a man aged 60 today who wants a pension of £66,000 a year, with a widow's pension of two-thirds assuming she is three years younger, guaranteed for ten years and life thereafter based on the first annuitant, with both pensions set to escalate at 5%. If you can find anywhere that you can buy that for £1.4 million I’ll eat my hat. And yours too, if you wear one.
In fact I've just done a quote and you need a fund of around £2.6 million!
Well, rant over, and having waited for the keyboard to cool down a bit, I’ve just re-read it all and I have to say I’m sorry if this BeeLine’s been a bit on the ‘techy’ side. Sometimes I just can’t help it.
3 December 2003
The information provided is based on Scottish Life’s understanding of current legislation and regulations, the Inland Revenue’s proposals and the Pensions Green Paper issued on 17 December 2002. These proposals are subject to consultation and may change in the future.