Whilst there is no prescribed limit on the total pension an individual can save, the Lifetime Allowance (LTA) is the effective maximum without triggering tax charges. Long gone are the heady days of a £1.8 million LTA in 2011, in fact the limit was systematically reduced to £1 million in 2017/18. Today, however, the 2018/19 Lifetime Allowance is £1.03 million and is set to increase annually in line with inflation, assuming legislation does not change again. Do bear in mind that historically the LTA has been reduced significantly as an easy tax revenue for HMRC. With recent discussions regarding the NHS’ financial situation and a potential tax increase, the LTA may be an easy target.
There is no immediate charge when your pension fund grows above your Lifetime Allowance, it is only charged when you begin to take pension benefits over the allowance, and is only calculated on specific events; when you start to take pension benefits, at age 75 and upon death.
You will pay a tax charge of:
A higher allowance; historic protections
To help offset your potential LTA liability the government have introduced various protections, which are rather complicated and may affect your future retirement planning. To choose the right protection and implement it correctly, we recommend seeking advice.
The Defined Contribution trap
For many a pension fund of £1.03 million may seem unobtainable, but after increased levels of contributions following a resurgence of optimism after Pension Freedoms, and a ten-year bull run, you might be surprised how close you are to the limit, especially if you have a few funding years ahead of you.
Consider the accumulated effect of having other pensions elsewhere, keeping track of where you are can be a challenge. Looking to the future, if you are in your 50s then a £750,000 pension fund after growth may easily exceed the LTA.
Defined Benefit Schemes
There is a similar risk considering Defined Benefit schemes; senior employees paying in to a long-term Defined Benefit scheme should seriously consider their situation.
To account for Defined Benefit 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 allowance. It’s very likely you’ll have other workplace and personal pensions also, so you can see how relatively easily LTA can be exceeded.
A high Cash Equivalent Transfer Value would also pose a similar issue on the rare occasions it’s right to transfer out of a Defined Benefit scheme.
The importance of planning
Considering the LTA level fluctuating significantly over time, and Pension Freedoms making the impact it has, the necessity to continue planning for retirement is as prevalent as ever; minimising potential tax due is crucial. It is also important to understand other options.
With increasing life expectancy, it may be prudent to build your retirement wealth outside of pension arrangements, and hence the limitations of Lifetime Allowance. The current tax-free ISA allowance is £20,000 per person, per tax year, and should be utilised annually.
In some circumstances, however, exceeding the Lifetime Allowance may be the best option. If you are still in employment, continuing pension contributions would mean you don’t miss out on valuable employer contributions. Even if this is subject to 25% tax as regular income above LTA, your employer matched contribution negates the cost. Finally, pensions are typically not subject to Inheritance Tax, as alternative investments such as ISAs are likely to be.
Fundamentally, having a pension approaching or exceeding the Lifetime Allowance doesn’t mean your retirement saving should stop, but there is a real chance the LTA may affect you. Boolers can help, having a team of expert pensions specialists offering bespoke advice. Effective pension planning is complex; financial planning will help simplify the situation.
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