IFS: Think beyond LTA on pensions tax
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The new government should “improve and rationalise” pensions tax by introducing a limit on how much can be passed on tax-free, the Institute for Fiscal Studies has said. It also proposes reducing the tax-free allowance on accessing a pot, while increasing the annual allowance.
When chancellor Jeremy Hunt abolished the lifetime allowance, shadow chancellor Rachel Reeves pledged to reintroduce it should Labour form the next government.
However, the IFS believes simply bringing back the LTA “would represent a missed opportunity to improve and rationalise the system of pensions taxation”, calling the pensions tax system “overly generous to high earners who get sizeable employer contributions”, in a briefing paper published on Tuesday.
It reiterates a view presented in a paper last year in which it advocated treating pensions as part of the estate for inheritance tax purpose. The institute now says the case for taxing pensions on death is stronger than the case for reimposing the lifetime allowance. IHT is not usually payable on pension pots, but income tax is due if the deceased was older than 75.
The institute also suggests bringing in a more generous annual allowance while reducing the cap on the amount that can be taken from a pension pot free of income tax.
“Rather than a simple kneejerk return to the system of two years ago, a new Labour chancellor would be well advised to implement a comprehensive and lasting reform which could rationalise, simplify and make fairer the current system of pension taxation whilst also raising revenue in the medium term,” said deputy director Carl Emmerson.
“The danger is that a reintroduced lifetime allowance ends up being just another bump in the pensions tax road, and another missed opportunity to rationalise the system with a coherent package of measures,” he argued.
Mubin Haq, chief executive of the abrdn Financial Fairness Trust, which sponsored the paper, said reversing the LTA abolition is right if other pensions tax reliefs are not cut back.
“Better would be to implement reforms such as reducing the maximum amount that can be taken tax-free from a pension pot and closing the loophole which allows pension pots to be passed on without payment of inheritance tax. These changes would weaken the case for reintroducing a lifetime allowance at the same level as it was before and could allow greater support for those with smaller pensions,” said Haq.
If these proposed reforms were adopted by a new government, there would be a case for setting any reintroduced lifetime allowance at a higher level than previously, the IFS added.
Simply bringing the LTA back in at its previous level would raise close to £800m a year, it has calculated, saying there was therefore “some merit” in Labour’s proposal if no other pensions tax changes are made.
When it was abolished, the lifetime allowance was £1,073,000 and frozen until 2026. A tax charge applied if people exceeded it, although in practice, few were affected by this.
The difficulty for past governments has been that many of those most likely to be at risk of exceeding the LTA are doctors. The British Medical Association said previously that large numbers were planning to take early retirement or reduce their hours because they might otherwise have to pay a hefty tax charge, with the NHS already short of doctors. When Hunt announced that the LTA would be scrapped, the BMA called it the end of a “pension tax trap” for senior doctors, hailing it as a success after years of campaigning. The argument with the BMA over pensions tax took place in tandem with a pay dispute, with junior doctors due to walk out again just before the general election of 4 July.
Hunt was not the first chancellor to consider lifting or removing the LTA. Just after the 2022 ‘mini-Budget’, the Sunday Telegraph reported that the Treasury saw lifting the allowance as a good way to keep doctors and other high-earning public sector employees working. The various tax cuts announced in late September, together with the absence of a forecast by the Office for Budget Responsibility, led to a severe gilts sell-off and Tory revolt that forced former PM Liz Truss to resign in October that year.
“Better would be to implement reforms such as reducing the maximum amount that can be taken tax-free from a pension pot and closing the loophole which allows pension pots to be passed on without payment of inheritance tax. These changes would weaken the case for reintroducing a lifetime allowance at the same level as it was before and could allow greater support for those with smaller pensions,” said Haq.
If these proposed reforms were adopted by a new government, there would be a case for setting any reintroduced lifetime allowance at a higher level than previously, the IFS added.
Simply bringing the LTA back in at its previous level would raise close to £800m a year, it has calculated, saying there was therefore “some merit” in Labour’s proposal if no other pensions tax changes are made.
When it was abolished, the lifetime allowance was £1,073,000 and frozen until 2026. A tax charge applied if people exceeded it, although in practice, few were affected by this.
The difficulty for past governments has been that many of those most likely to be at risk of exceeding the LTA are doctors. The British Medical Association said previously that large numbers were planning to take early retirement or reduce their hours because they might otherwise have to pay a hefty tax charge, with the NHS already short of doctors. When Hunt announced that the LTA would be scrapped, the BMA called it the end of a “pension tax trap” for senior doctors, hailing it as a success after years of campaigning. The argument with the BMA over pensions tax took place in tandem with a pay dispute, with junior doctors due to walk out again just before the general election of 4 July.
Hunt was not the first chancellor to consider lifting or removing the LTA. Just after the 2022 ‘mini-Budget’, the Sunday Telegraph reported that the Treasury saw lifting the allowance as a good way to keep doctors and other high-earning public sector employees working. The various tax cuts announced in late September, together with the absence of a forecast by the Office for Budget Responsibility, led to a severe gilts sell-off and Tory revolt that forced former PM Liz Truss to resign in October that year.
