Why removing the lifetime allowance is going to be difficult

Over a long career, I have lived through several big changes in pensions.

From the 1997 GMP changes, the introduction of stakeholder pensions, pensions simplification through to pensions freedom, each initiative shook up the pensions world. Looking back these changes seem to have come about every seven years, so we were probably due a new one, and that came in the Spring Budget.

The abolishment of lifetime allowance charges, which came into effect in April, and the promised removal of the lifetime allowance next tax year should have simplified the pensions environment. And to a large extent it has done. Many of the queries I have received from financial advisers in recent years have centred on the age 75 benefit crystallisation event and whether their client would be better withdrawing drawdown income to avoid a lifetime allowance charge or running the risk of a higher inheritance tax bill. That quandary disappeared overnight.

But that doesn’t mean the new rules are simple. A case I saw this week about a client who had used 100% of their lifetime allowance and died with several resulting death benefit pay-outs sent a nasty reminder that complexities still riddle the pension tax rules.

The Finance (No. 2) Bill – soon to be legislation – has got rid of the lifetime allowance charge, but more tax rule changes are coming.

The Chancellor promised to abolish the lifetime allowance completely. HMRC now has the unenviable task of putting that promise into practice in next year’s Finance Bill. This summer it has to draft up the new rules which will eradicate mention of the lifetime allowance. This is no simple task. The lifetime allowance was one of the dual planks pensions simplification was built on in 2006 (the other being the check on contributions – the annual allowance). To remove it requires a Jenga-style move that could result in the tower of pension tax rules crashing down.

We know the new rules will be predicated on the principle that someone can only have a limited amount of tax-free cash – starting off at £268,275 (25% of the current lifetime allowance). So presumably this will be a new limit or allowance. But beyond that we know little of what HMRC is planning or what mandate they’ve been given by the politicians.

How will this new limit work? Will there be a disconnect between taking income and taking tax-free cash – so clients could take all their cash from one scheme, and all their income from another? The signs are lifetime allowance protection is still going to be part of the new world as it will allow those with protected higher tax-free cash amounts to keep them. But will those protection rules change in any way?

What is for sure is that these new rules have to be simple. Financial advisers and their clients have to have the confidence that the rules are approachable, easy to understand, with nothing lurking to trip them up either now or later down the line.

Removing the lifetime allowance should be a step forward in simplicity. Whatever comes next cannot take us back to the beginning by adding complexity and obfuscation.