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Beating the lifetime allowances changes
Since it was introduced in 2006, The Government has been gradually reducing the Lifetime Allowance (LTA) on pension contributions – that is the total sum that a person can save into their pension over their lifetime and receive tax benefits on the money paid in.
From 6 April 2016 the LTA will reduce to its lowest level yet – from £1.25m to £1m. It will remain at this level for two years until April 2018, when, under current plans, it will start increasing each year with inflation, in line with the Consumer Price Index (CPI), assuming inflation rises.
This latest reduction, of course, will bring more pension savers within its sights. In fact, according to latest HM Revenue & Customs’ estimates, somewhere in the region of 360,000 high earning pension savers will face a tax bill equivalent to several years’ salary if they exceed the new lower lifetime pensions allowance.
What happens is that for anyone over the £1m limit, HMRC will apply an LTA tax charge on money withdrawn from the pension, whether as a lump sum or as income, designed to take away the benefit of tax relief for savings above the LTA. Any excess amount over the LTA will be taxed at 55% (if taken as a lump sum) or 25% (if taken as income).
The question is how likely is someone to breach the new limits? The government says the LTA will increase by CPI from April 2018, which they expect will be around 2%. At this rate the LTA will be £1.17m in ten years, and £1.43m in 20 years. So taking into account an annual growth rate of 5%, any individual with a fund currently worth £538,000 with 20 years to go until retirement is likely to hit the LTA. Similarly, someone retiring in 10 years with a pension pot today of £719,000 would also reach the LTA ceiling. And, of course, these days many people have more than one pension fund, which can make the calculation more complicated.
What can be done to avoid LTA tax charges?
Fortunately, at the same time as applying these reductions HMRC recognises that it would be unfair to penalise people who have been saving to the old LTA rate and as a result would breach the new lower rate. Hence, in the past HMRC has offered two types of ‘transitional protection’ and April 2016 is no different.
Individual Protection 2016 is available for those with pensions valued at more than £1m on 5 April 2016. The value, up to a maximum £1.25m, becomes a personal LTA and allows further pension contributions to be made to existing or new pension schemes. This is not available for anyone who has already taken out this kind of protection at an earlier date.
Fixed Protection 2016 This, as the name implies, allows the LTA to be fixed at £1.25m but no further pension contributions are allowed. This can be useful if a pension fund is expected to grow to over £1m, or if the fund is already over £1m. Again, it is not available for anyone who already has primary or enhanced protection, or fixed protection 2012 or 2014.
Choosing to protect the LTA won’t be right for everyone. Pension values as well as time to retirement are clearly important factors so this is an area where individual retirement goals are very important.
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