Thousands of pension savers could be impacted by unless they act swiftly
If you are making high levels of pension contributions you will need to obtain professional financial advice to make sure that you know whether you will be affected by the impending new lifetime allowance (LTA) limit changes. Thousands of pension savers could be impacted by the forthcoming changes unless they act swiftly.
Your total pension savings
You should check what the value of your total pension savings will be as at 6 April 2014. It is also particularly important to bear in mind how much money you have accumulated in any legacy pension schemes from a previous employer, as your current employer will not necessarily know you have one and will therefore not count this towards your total amount.
According to Standard Life, if you’re 10 years from retirement with a current pension fund of £700,000 you could exceed your allowance if your pot grows at 7% a year – even if you don’t pay another penny into it. Yet it’s unlikely you were even aware you had a problem. Of course, growth could be higher or lower depending on your investment performance and we don’t know what the allowance is likely to be in 10 years’ time.
Linked to your final salary
It’s even trickier with some company pension schemes which are linked to your final salary. It’s easy to underestimate just how valuable a final salary pension is – or how it’s tested against the LTA. You could be surprised to learn, for example, that a £25,000 paid-up pension from a previous job already eats up £500,000 of your allowance. Adding in revaluation for leaving up to retirement, at say 3.3% over 10 years, takes the pension up to £34,590 – using up almost £692,000 LTA.
You can save as much as you like towards your pension but there is a limit on the amount of tax relief you can get. The LTA is the maximum amount of pension saving you can build up over your life that will benefit from tax relief. If you build up pension savings worth more than the LTA you’ll pay a tax charge on the excess.
An individual’s entire pension savings
From 6 April 2014 the LTA will reduce from £1.5 million to £1.25 million. It applies to an individual’s entire pension savings (apart from the State Pension). The figure may sound high but many thousands of people could be affected, especially those in final-salary schemes who have built their entitlement through many years’ work.
If your pension savings are worth more than the LTA when you take your benefits, you’ll have to pay the LTA tax charge on the excess unless you have some form of LTA protection. The rate depends on how this excess is paid to you. If the amount over the LTA is paid as a lump sum – the rate is 55%, and paid as pension – the rate is 25%.
Many people had built up pension pots worth more than £1.5 million before 6 April 2006 when the LTA was introduced. LTA protection was introduced so that they didn’t have to pay the LTA tax charge on pension funds built up before this date.
Two ways you can protect yourself
There are two ways you can protect yourself from paying the LTA charge. The most common is to apply for ‘Fixed Protection’, which effectively caps your LTA at £1.5 million.
The scheme, termed by HMRC as Fixed Protection 2014, allows savers with pensions likely to exceed the £1.25 million cap to apply now – before the deadline of 6 April 2014 – for an extension to the limit. Applying for the protection will benefit those near to retirement and wanting to maximise the value of their pot – as well as savers who expect the value of their pension to grow without making any new contributions.
There are a number of restrictions to be aware of. Individuals in defined-contribution pension schemes cannot add new benefits to their existing pot. Pension savers in defined-benefits schemes can only build up benefits in line with inflation on an annual basis. No new pension arrangement may be started, other than to receive a transfer of rights from an existing pension arrangement.
An attractive alternative solution for individuals
The second way to avoid the 55% tax penalty is to apply for ‘Individual Protection’. This option may be an attractive solution for individuals who will not receive any alternative remuneration from their employer if they opt-out of their pension scheme. Savers can apply for this protection from April 6.
It is possible to apply for both Individual Protection and Fixed Protection. This would give you a LTA of £1.5 million (Fixed Protection) and contributions must stop. If you choose to restart contributions in the future, your Fixed Protection would be lost. But you would still benefit from your Individual Protection allowance rather than the standard £1.25 million LTA.
The annual allowance, meaning the amount of pension savings or contributions that can be made in any one year, will also reduce commencing 6 April 2014 from £50,000 to £40,000. The rules for the annual allowance are more complicated than those for the LTA.