With the prospect that most of us will be living longer it seems strange that any Government would seek to limit the amount we can save into our pensions.
In April, the amount maximum that can be saved without incurring a tax charge was reduced to £1 million. This is what’s know as the Lifetime Allowance and this is the third time the Government have lowered it. Whilst £1 million may still seem beyond the reach of the man in the street, many will be caught out, often to their complete surprise. The restrictions on how much can now be saved is a reflection on how valuable the tax advantages pensions now offer. Those tax advantages benefit the individual at the cost of the tax man and this is worth bearing in mind even if you don’t think you will ever reach the Lifetime Allowance.
So what is the Lifetime Allowance? It is the value of pension benefits, whether lump sums or retirement income that can be accrued without triggering an additional tax charge. The tax charge is levied on the amount in excess of the Lifetime Allowance when benefits are taken. If benefits received are in excess of the Lifetime Allowance, then any further lump sums are taxed at 55% and any funds drawn as income would suffer an additional tax levy of 25%, over and above the income tax that would also be due. A Lifetime Allowance charge may also be levied on death before age 75 when a person’s pension benefits are valued in excess of the Lifetime Allowance.
Even if you don’t have a pension fund with a value anywhere near a million you could still be caught. Not only do savers have to consider future contributions and fund growth but also, members of defined benefit or, final salary pension schemes do not escape. Many high earners who are drawing to the end of a career in for example, the Civil Service or the NHS are discovering that they could be subject to these penal tax charges. As a rule of thumb to establish the deemed value of your final salary pension benefits, multiply the expected pension by twenty and add your expected tax free cash. If this, once added to the value of any other pension benefits you have accrued, comes close to or, exceeds £1m then you potentially breach the Lifetime Allowance and could therefore be subject to the additional tax charges.
For those that are potentially caught, it is possible to apply for ‘Protection’ against the new limits and subsequent tax charges applying. This is a complex area with a number of different protections available which, in some cases allow up to £1.5 million to be sheltered. It is important to consider how the Lifetime Allowance could affect you and explore whether you should apply for the relevant form of protection to limit the amount of tax that could possibly be levied. If you are a high earner and or, have made significant pension contributions this is an area which you should take advice on sooner rather than later.
If you are never likely to breach the Lifetime Allowance then that’s one less thing to worry about but the reduction in the allowance should serve to highlight that, certainly under the new pension’s regime, pensions have become an extremely attractive savings vehicle – if others are being penalised for taking too much advantage, shouldn’t you be making the most of your allowances?