In November’s Autumn Statement, despite speculation, no further news was delivered in regard to the Lifetime Allowance (LTA) or Annual Allowance suggesting that they will continue to remain frozen for three more years.
As of December 2022, the UK Inflation rate stood at 10.5% and the Lifetime Allowance of £1.073m has effectively lost £112,676 of value in real terms in the last year alone. Therefore, people’s pension savings will likely start catching up with the frozen Allowance. Whilst a savings limit of over £1m sounds like a huge sum, as people’s wages increase, many middle earners who save regularly over a lifetime may eventually hit the limit without even realising that they are at risk. WEALTH at work has therefore identified those people it thinks may be affected the most. This includes:
1. Those who are blissfully unaware
Most people probably think that they aren’t one of the lucky ones to have a pension pot valued at the current LTA limit 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 in 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 for the purpose of testing it against the LTA. Further to this, any tax-free cash received from the pension will also need to be added to this figure and tested against the member’s available LTA.
If someone with a DB scheme decides to transfer the arrangement into a defined contribution (DC) scheme to take advantage of the pension freedoms, the transfer values offered can be much higher than the twenty times multiple used for 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.
2. Those who think they are a long way off
This group of individuals believe that they are a long way from breaching the LTA, but in fact, aren’t. This is particularly the case where they are making healthy contributions to their pension scheme and perhaps receiving matching employer 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% p.a. 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 any future increases in the LTA could be modest so you could end up exceeding the Allowance by retirement.
*Assumes growth rate of 5% and excludes charges on the pension plans.
3. Those who think they are protected but aren’t
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 contribution could invalidate protection previously granted, without them even realising. Responsible employers will inform employees they plan to re-enrol in order that the contributions can be stopped in time.
There are some options that people should be aware of to either avoid or reduce the impact of the LTA:
- Review their current situation – If they have already taken some pension benefits, they 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.
- Consider alternative savings vehicles – Individual Savings Accounts and workplace share schemes are two tax-efficient saving vehicles to consider saving in as an alternative, or supplementary to a pension.
- Opt-out – Some 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. Individuals need to understand that a decision to opt-out of a workplace pension should not be taken lightly and that it could well be in their best interests to remain active in the pension scheme despite a potential tax charge. If someone is considering opting-out then it’s best that regulated advice is received from a suitably qualified adviser.
- Take early retirement – A simple way to avoid exceeding the LTA, or incurring further charges, is to stop contributing into a pension and take early retirement. Again, it’s important to consider the options available and it may be beneficial to seek regulated financial advice.
Jonathan Watts-Lay, Director, WEALTH at work, comments;
“Having over £1 million in pension savings may seem unrealistic to most, especially in the current climate, but reaching the LTA could be closer than many people think. 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 potentially lead to 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, so it’s always worth asking what help is available. This approach helps employees understand all their options before making what could be life-changing decisions, therefore leading to better outcomes at retirement.”