Someone aged 45, with a pension fund of £400,000 and a salary of £50,000, could have a pension fund of £1,381,000 by the time they retire at 65*.
As announced in the Budget, the Lifetime Allowance (the amount of savings which can be built up in a pension and receive tax relief) will remain at its current level of £1,073,100 until April 2026. It’s been predicted that an estimated 10,000 individuals with large pension pots will pay more than £22,000 extra in tax by 2024.
WEALTH at work believes that the Lifetime Allowance (LTA) will typically affect one of the following three groups. By highlighting this, it can help people identify if they may be at risk of breaching it and receiving an unexpected tax charge, so that the appropriate measures can be considered.
Those who are blissfully unaware
Most probably think that they aren’t one of the lucky ones to have a pension pot valued at the current LTA limit of £1.07 million or more – but it’s quite possible that the value of their pot is far higher than they realise and they may have already breached the allowance. This could particularly affect those who never check the value of their pension, or haven’t done so for some time. Also, many people with defined benefit (DB) pension schemes are unaware that their pension is valued at twenty times their annual pension for LTA purposes, and so an annual pension of £30,000 has a value of £600,000. Also, any tax free cash received from the pension will also need to be added to this figure and checked against the persons available LTA.
If a member of a DB scheme decides to transfer their pension savings into a defined contribution scheme to take advantage of the pension freedoms, the transfer values offered can be much higher than the standard method of working out the LTA value. For example, transfer values can be as high as forty times the annual pension, and so, using the above example, an annual pension of £30,000 could have a transfer value of £1.2m and therefore exceed the current LTA.
Those who think they are a long way off
This group believe that they are a long way from breaching the LTA, but in fact aren’t. This is particularly the case where people are making healthy contributions into their scheme and perhaps receiving matching contributions. Positive pension fund growth as well as a pay rise may easily push them over the LTA before they know it.
For example*, if someone aged 45 has a pension fund of £400,000 and a salary of £50,000, saves 5% of their salary into their pension which rises by 3% each year and receives employer contributions of 10%, it is possible for their pension fund to reach £1,381,000 by the time they retire at 65. With the LTA presently frozen until April 2026, you could easily end up exceeding the allowance by retirement.
*Assumes growth rate of 5% and excludes charges on the pension plans.
Those who think they are protected but aren’t
Some people who have taken protection measures and opted out of their workplace pension scheme to safeguard their savings from a LTA charge, could still be at risk of a breach. This is because of how the rules around auto-enrolment work, meaning that employees are re-enrolled every three years.
Just one month’s contributions could invalidate protection previously granted, without someone even realising. Responsible employers will inform employees whom they plan to re-enrol, so that they’re aware that pension contributions will be deducted from their monthly pay, but this may not be the case.
There are some steps that people can take to either avoid or reduce the impact of the LTA:
1. Review current situation – If they have already taken some pension benefits, individuals should start by looking at a current pension valuation and assessing how much of their LTA they have used. If they have more than one pension, they will need to add up what they’ve accumulated across all their pensions to work out the full amount.
2. Consider alternative savings vehicles – Individual Savings Accounts and workplace share schemes are two tax-efficient savings vehicles for people to consider saving in as an alternative, or supplementary to a pension.
3. Opt-out – Some people may choose to opt-out of their workplace pension scheme for LTA purposes especially if their employer is offering cash in lieu of the employer pension contribution. Also, people need to understand that a decision to opt-out should not be taken lightly and that it could well be in their best interests to remain active in their pension scheme despite a potential tax charge. If you are considering opting-out then it’s best that regulated advice is received from a suitably qualified adviser.
4. Take early retirement – A simple way for people to avoid exceeding the LTA, or incurring further charges, is to stop contributing into their pension and taking early retirement.
Jonathan Watts-Lay, Director, WEALTH at work, comments;
“Whilst having over £1million in pension savings may seem unrealistic to most, reaching the LTA could be closer than many people think. This will especially be the case now that the allowance has been frozen, as we will see more individuals reach the threshold over time. And it’s not just high earners and those with defined benefit schemes that will be affected, but those who have saved from an early age, and whose investments have performed well. The tax implications could be drastic and could lead to potentially many being hit with unexpected and sometimes unnecessary tax bills.
Many workplaces now offer support to their employees in terms of financial education, guidance and regulated financial advice. This approach helps people understand all their options before making what could be life-changing decisions, therefore leading to better outcomes for all.”