Pension Lifetime Allowance: are you sleepwalking towards a massive retirement charge?


Updated on 16 October 2019 | 1 Comment

Sine 290,000 people have already breached the Lifetime Allowance, with over a million more at risk of high taxes.

As many as 1.5 million people could find their pensions decimated by taxes, new research has found.

Some 290,000 already have pension savings above the Lifetime Allowance, according to research by pensions provider Royal London.

A further 1.25 million could breach the Lifetime Allowance by the time they retire, with senior public servants and those with salaries of £60,000 to £90,000 per year particularly affected.

To make matters worse, half of those who had already breached the Allowance were continuing to save into their pensions.

The Lifetime Allowance, which is currently £1.055 million but set to rise slightly to £1.073 million in April 2020, is the maximum amount you can accumulate in your pension before you get taxed.

Any amounts above the Lifetime Allowance are subject to a 55% tax.

Steve Webb, director of policy at Royal London and ex-pensions minister, warned of a "Lifetime Allowance timebomb".

"It is shocking that over a quarter of a million people have already breached the LTA and that many of these are still adding to their pensions. 

"Many workers, especially those in Defined Benefit pension schemes, will have little idea that this is an issue and could be heading for a nasty jolt."

Four tax-free ways to access your pension savings

The Pension Lifetime Allowance

Back in 2006-7 the Pension Lifetime Allowance was first introduced. As the name suggests, this is a cap on the amount that you can save into your pension during your lifetime, without a tax charge being levied.

When the allowance was first introduced, it was set at £1.5 million and was then raised over the following years to a massive £1.8 million.

Let’s be honest, that’s a figure that is really beyond the concern of the vast majority of pension savers, no matter how diligently they may put aside money to cover their later years.

However, the allowance has been slashed significantly since 2011-12, falling from a peak of £1.8 million to the £1.03 million it sits at today.

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How does this tax work?

Unsurprisingly, this drastic lowering on the cap has seen the Government enjoy much higher tax receipts from pension savers breaching the cap.

Figures from HM Revenue & Customs suggest that the tax raised from breaches of the allowance have more than doubled in the last couple of years, from £30 million in 2014-15 to a whopping £110 million in 2016-17.

The rate of tax that you pay on your pension savings above the allowance basically comes down to how you access that cash. If you take the excess  the amount above the limit  as a lump sum, then there is a massive 55% charge.

However, if you take it out in any other way then there is a 25% tax levied on the money.

Do I really need to worry about it?

Building a pension nest egg worth more than £1m may seem like a pipedream but it really isn’t as unlikely as you may think.

Those figures from HMRC reveal that the number of savers caught out by the allowance doubled from 1,020 to 2,410.

OK, that’s still a relatively small number, but there are concerns that increasing numbers of us are going to be subject to the tax in future.

The tax specialists at accountants RSM have warned that many more people may be “sleepwalking” towards being caught out by the Pension Lifetime Allowance due to a combination of a lack of engagement with their existing pension pot and the Government’s attempts to boost pension saving across the nation.

Jackie Hall, tax partner and head of employment taxes at RSM, said that workplace pensions  where employers are forced to enrol their staff into a pension and then contribute towards it  may present a “particularly nasty problem” in exposing savers to a penalty charge.

She explained: “An employer must re-enroll all employees every three years, including those who have previously opted out.

"Some of those opting out may have done so because they were at or close to the LTA and had applied for one of the protections available at various times.

"Such protection is unfortunately lost where any further contributions are made to any scheme, resulting in a potential tax charge of up to 55% on the fund.”

Pension freedoms: all you need to know

How to avoid falling foul of the Pension Lifetime Allowance

The key to ensuring that as much of your pension saving ends up in your hands, rather than the taxman’s, is to keep engaged with how your pensions are performing.

It doesn’t have to be a daily thing, but every couple of months check how your pot is looking. As you get closer to the lifetime allowance, you may then want to take steps to put money aside elsewhere in vehicles that aren’t subject to the allowance.

For example, you might want to start putting your usual pension contributions into an ISA instead. Bear in mind that you will be giving up the contributions from the Government here though.

If you are married, you can make contributions towards your partner’s pension. If their pot is not looking quite as rosy as your own, then you could instead choose to divert your usual payments into their pension.

Of course, you could always do nothing and simply accept the tax hit.

As Les Cameron, retirement planning expert at Prudential, points out: “You don’t refuse a pay-rise, which increases your income tax bill as you value the net benefit.

The exact same principle should apply to your pension – if the net benefit is worth it, you should keep going.”

For those who want to keep their pension tax bill to a minimum, have a read of this guide to accessing your retirement savings. For any other retirement questions, you can check out our comprehensive guide to pensions.

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