Those with a sizeable pension fund may need to take action before April to avoid an unwelcome tax charge
On the face of it, you can understand why the government places a limit on pension saving. Contributions into a UK-registered pension scheme attract tax relief on the way in and accumulate capital gains free of tax once inside. By ensuring that these tax breaks are not entirely open-ended the government controls the distribution of state support to middle and high earners. But given that most of the £34 billion a year paid in pension tax relief goes to the wealthiest1, there is pre-Budget speculation over whether these controls will need to be tightened further.
One such control is the lifetime allowance charge. This effectively places a cap on the overall value of pension assets that can be accumulated – and anyone exceeding it pays tax at 55% when money is taken back as a lump sum, or at 25% on top of Income Tax if money is taken as pension income.
But the lifetime allowance is not a restriction on the amount you can contribute to a pension each year; it’s a ceiling on the overall size of your pension fund. From that perspective, it is as much a penalty for good investment performance as it is a measure to curb tax privileges.
Dr Ros Altmann, who served under David Cameron as Minister of State for Pensions, opposes the lifetime allowance on the grounds that it penalises investment success. “Surely the point of pension saving is to benefit from long-term investment returns. That means it makes sense to limit the amount people can put in with the help of tax relief, but does not make sense to then try to punish them if their fund grows sharply,” says the former minister.
When it was introduced in 2006, the lifetime allowance stood at £1.5 million. It was then increased each year, reaching £1.8 million by 2010. But since then it has been cut every two years. Today the lifetime allowance stands at £1 million, putting swathes of investors within range of an unexpected tax charge when they take their benefits. What is more, a pension fund that might appear modest today could exceed the lifetime allowance by the time savers want to access their benefits.
“Moving the goalposts in this way makes it much harder for people to plan their retirements,” says Ian Price, divisional director at St. James’s Place. “Even if your pension assets are less than the lifetime allowance – and you have ceased making pension contributions – investment growth on its own could be enough to tip the pension through the lifetime allowance ceiling,” he says.
From April 2018 onwards the lifetime allowance will rise in line with the consumer prices index.
On the plus side, every time the lifetime allowance has fallen, the government has offered protection for those people who have pensions above or close to the new lifetime allowance. With protection in place, savers have been able to lock in their own allowance up to the level of a pre-existing limit.
You can for example, still apply for ‘Individual Protection 2014’ (IP14), which allows you to retain a maximum allowance of £1.5 million. To qualify, the value of your pension savings must have been between £1.25 million and £1.5 million on 5 April 2014. Crucially, those who are eligible for IP14 shouldn’t delay as applications will no longer be accepted after 5 April 2017.
Protection is also available for those caught by the most recent reduction, when the lifetime allowance dropped from £1.25 million to £1 million on 6 April 2016. Unlike IP14, the government has not set a deadline for these applications.
“You can apply for the various forms of protection via the government’s online service,” says Price. “It’s a complicated area of financial planning, so I would always recommend that the application process is completed with help from a financial adviser. They will also help you calculate what the value of your fund was on the appropriate dates.”
The run-up to April is often a time to ensure allowances and exemptions are fully utilised, but alongside the well-established ideas for the end of the tax year, those with a significant pension fund, or aspirations to create one, should explore whether they need to protect their fund from an unnecessary tax charge – and in some cases before the opportunity is lost.
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.