Pension reforms throw up another “unfair” DC/DB inconsistency

Several industry voices have warned of the unfair inconsistency the reduction in the lifetime allowance has to defined contribution members.

Aon Hewitt partner Lynda Whitney said there is a “stark inconsistency” between the effects of the new lifetime allowance of £1m on DC and DB schemes.

“In the DC world, £1m may buy an increasing pension of only around £25,000pa, while in the DB world you are allowed a pension of £50,000pa without breaching the lifetime allowance. This is because HMRC uses a fixed factor of 20 to calculate the lifetime allowance for a DB member and you cannot currently buy £1pa of increasing pension for anything like as low as a £20 premium,” she explained.

Broadstone pensions director Simon Nicol said one way to correct this would be to significantly increase the multiple applied to final scheme income for lifetime allowance testing. However, he said this would start to bring those with final salary income of £25,000 a year into the tax charge.

“Alternatively for those buying an annuity, and therefore turning their fund into a final salary like income, they could also have their lifetime allowance test against the actual income being paid at a 20 times rate not as currently on the purchase price,” he added.

Smith and Williamson financial services director Mike Fosberry described the reduction as another “attack on the pension savings of those in the private sector, whilst exempting public sector pensions, funded out of general taxes,” adding that it is not fair.

“When the Chancellor states that only 4 per cent of individuals have a pension pot worth £1m at retirement, his figures would be rather different if they included public sector workers with a pension entitlement of more than £29,000 per annum,” he said.

Fosberry stated he welcomes the retention of the £40,000 annual allowance but it seems unclear why it is the private sector that should bear the brunt of these changes, given the country is bearing the entire cost of public sector pension contributions not just the tax relief on them.

However, President of The Society of Pension Professionals and Hogan Lovells partner Duncan Buchanan said that although there is an inequality there is a risk that the government might decide to level both down.

“If we’re not careful, making a lot of noise in this area, may convince the government to look at the 20 to 1 conversion factor, it may make DB members worse off without making DC members better off,” he said.

In addition, he said it is becoming a private versus public sector issue as in the private sector most people are in a DC scheme whilst DB has become the domain of the public sector. He added that MPs are in a DB scheme and there is a perception that they are getting a better deal for themselves.

Broadstone, actuarial director John Broome Saunders said that whilst it is an inconsistency that we will probably just have to live with.

“The only ‘solution’ would be to increase the current factor of 20, which, for DB members, would be equivalent to a further reduction in the LTA. This would require yet more ‘protection’ arrangements, and would lead to further justified criticism that the government is incessantly tinkering with pension tax rules, to the detriment of long-term pensions credibility,” he added.

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