Should the pensions lifetime allowance be reintroduced and, if so, how?

Shadow Chancellor Rachel Reeves has pledged that a Labour Government would reintroduce the pensions lifetime allowance. This was abolished by Chancellor Jeremy Hunt in his March 2023 Budget and was a tax cut for the small number of individuals who had, or would in future have, accumulated pension pots worth over £1,073,000.

Our system of pensions taxation is overly generous to high earners who get sizeable employer contributions (as these escape National Insurance contributions) and accumulate big pension pots. In the absence of more widespread reform, there is some merit in Labour’s proposal to bring back something like the lifetime allowance to limit the scope of these subsidies, and there would be advantages to doing this swiftly. Reintroducing the charge at its previous level might raise almost £800 million a year. But it would represent a missed opportunity to improve and rationalise the system of pensions taxation. That could include – among other things – a more generous annual allowance, a reduction in the cap on the amount that can be taken from a pension pot completely free of income tax and a new cap on the amount of pension wealth that can be bequeathed at death free of inheritance tax. In fact, the case for this latter set of reforms is stronger than the case for reimposing the lifetime allowance. If these latter reforms were included in a policy package, there would be a case for setting any reintroduced lifetime allowance at a higher level than previously.

Carl Emmerson, Deputy Director of the Institute for Fiscal Studies and co-author of the piece, said:
‘Given the current way in which we tax pensions there is a case for reintroducing a lifetime allowance. But that is mainly because so many other aspects of the system are overly generous to high earners who get sizeable employer contributions and accumulate big pension pots. 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. 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.’

Mubin Haq, Chief Executive of the abrdn Financial Fairness Trust, said:
‘Removing the pensions lifetime allowance was a giveaway to those with the largest pension pots; in 2021-22 only 11,000 individuals paid this charge with the average amount due being over £40,000 each. Reversing this change is right if other pension tax reliefs aren't 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.’