In Phillip Hammond’s recent Budget, much to the surprise of speculators, tax-free pension Annual and Lifetime Allowances emerged unscathed. Historically they have been the go-to HRMC source for increasing tax revenue, and a reduction looked likely to help plug the NHS budget deficit. Thankfully, other funding is apparently available, and you are able to save towards retirement without further restrictions.

However, the Lifetime Allowance (LTA), the total amount you can tax-efficiently save in pensions, is still catching many people out. In fact, the latest figures show the amount of tax revenue HRMC received as a direct result of people exceeding the LTA increased 2,000% between 2006/07 and 2016/17. That makes for a whopping £102 million of tax paid in 2016/17, often by people blissfully unaware they were exceeding the LTA.

How you’re taxed

There is no immediate charge when your pension fund grows above the LTA. The charge is calculated on three specific events;

  • When you start to take pension income
  • At age 75
  • When you die

You will then pay a tax charge of;

  • 25% of any amount over the LTA taken as regular income
  • 55% of any amount over the LTA you take as a lump sum

Why’s tax revenue increased so much?

Back in 2006/07, the Lifetime Allowance was £1.5 million. This rose to a peak of £1.8 million in 2010/11. Today it stands at just £1.03 million. It should come as no surprise during the same time the LTA has been systematically reduced, tax paid for exceeding it has increased significantly.

The LTA is now set to increase every year in line with inflation, but high-earners could still easily exceed the figure. Research by consumer group Which? suggests for an annual income of £39,000 you would need a pension fund of around £1 million in order to purchase the necessary Annuity. If you’d like a higher level of income from your pensions, it’s almost certain that you would exceed the LTA and end up paying more tax. It does depend on your personal circumstance, however, as this may still be the most efficient way of saving towards your retirement.

The effect of Defined Benefit pensions

To account for Defined Benefit (DB) schemes you multiply the annual income it will provide by a ‘standard valuation factor’ of 20:1. For example; if the schemes provides an annual income of £35,000 the value to consider is £700,000, or 68% of the 2018/19 LTA. It’s very likely you’ll have other workplace and personal pensions too, so you can see how easily the limit can be exceeded.

Given that Cash Equivalent Transfer Values (CETVs) have in recent times exceeded 30 or even 40 times the annual income otherwise provided, deciding to transfer out of a DB scheme may have the potential to breach the LTA without even considering other pension funds.

What can you do?

Unfortunately, your current employer and workplace pension provider may not have the qualifications or experience to advise you about the likelihood of exceeding the Lifetime Allowance, or the tax repercussions.

As the government statistics show, an increasing amount of tax is being paid as a direct result of this situation. Rather than adding to these statistics, to properly understand your retirement planning and Lifetime Allowance position, don’t hesitate to get in touch.

It may be that exceeding the LTA is the most tax-efficient way to plan for later life, especially if you are still receiving valuable employer pension contributions. This does, however, depend entirely on your personal circumstances and your use of other tax-efficient allowance such as the 2018/19 £20,000 ISA allowance. For tax-efficient retirement planning, our financial planners are here to help.