The million-pound drop
Does the drop in the lifetime allowance mean you should stop saving into your pension?
From next April, £1 million is the maximum the chancellor says he will allow anyone to have in their pension before the excess is taxed at 55%. The limit is called the ‘lifetime allowance’ and it is, in effect, a ceiling beyond which pension savings should not be allowed to rise.
One million pounds may seem beyond the reach of most people, but for thousands of workers, including middle managers, teachers, and doctors, a pension of this size is not uncommon or unachievable at retirement.
Moreover, responsible savers in their 30s and 40s with relatively modest pension pots can expect to reach the lifetime allowance by retirement, given a run of good investment returns.
The government stresses the need to make sure that the tax system incentivises more people to take responsibility for securing their financial future in retirement, whilst simultaneously denying diligent savers by restricting how much they can put away in their pension. Indeed, it was former pensions minister Steve Webb who said people in their 20s and 30s need to put 15% of their salary into a pension to achieve a comfortable retirement. Yet at that rate, and in certain circumstances, the lifetime allowance would be reached. It’s a curious state of affairs. Nevertheless, it appears that the limit is here to stay.
The lifetime allowance was introduced in 2006 at a level of £1.5 million and it has been steadily getting more restrictive over the last five years. The current level in the 2015/16 tax year is £1.25 million and this will reduce to £1 million from April 2016. From 2018 it will start to rise with CPI inflation.
“Dedicated savers need to keep an eye on their pension pot to make sure it doesn’t go over the lifetime allowance,” says Ian Price, divisional director at St. James’s Place. “If you’re still a long way off retirement, your pension could grow to exceed the lifetime allowance by 60 or 65,” he says. “It’s always best to speak to your adviser if you think you might exceed it,” he suggests. The graph below provides some food for thought.
Comparison of estimated pension value against the lifetime allowance
Assumptions: 50 year old male with total pension value of £500,000, ongoing gross contribution of £10,000 pa. Average growth 7% pa. Average charge 1% pa. Assumes lifetime allowance rises by CPI inflation at 2.5% pa from April 2018.
If you have a defined benefit (also known as ‘final salary’) pension, it’s a bit more difficult to work out if you will exceed the lifetime allowance. To give you an idea of the approximate value, you should multiply your annual pension income figure by 20 and add on any tax-free cash you are due. If you need an accurate figure, you should ask the company or organisation you work for. If you have several different schemes, you will need to combine the values.
Price says there are alternatives for saving if the lifetime allowance is an issue, but he recommends these are discussed with an adviser first. He says: “Rather than continue to fund your own pension, you can think about using your income to fund someone else’s pot – for instance, your spouse or partner.”
Payments that you make to your wife, husband or civil partner will receive basic rate Income Tax relief at source. Any higher or additional rate tax relief can only be claimed by them. “You can even contribute into a child’s pension if you like,” adds Price.
Alternatively, ISAs can provide a tax-efficient home for surplus income and, for the more advanced investor, there are alternatives such as Venture Capital Trusts and Enterprise Investment Schemes to consider.
If you already have over £1 million in your pension and you’re concerned about whether you can escape a 55% tax bill, it’s likely that there will be some form of transitional arrangement that will shield you from being penalised, up to the old allowance of £1.25 million.
“It’s likely this protection will be similar to what was put in place for the previous reductions, but we’re still waiting for detail from the government,” Price stresses.
“But the lifetime allowance serves as yet another reminder of the value of financial advice,” he says
The value of an investment with St. James's Place will be directly linked to the performance of the funds you select and the value can therefore go down as well as up. You may get back less than you invested.
The levels and bases of taxation, and reliefs from taxation, can change at any time. The value of any tax relief depends on individual circumstances.