Whats the issue?
The Pensions Lifetime Allowance Savings Limit (LTA) was originally introduced by HMRC to introduce an additional tax on the very wealthiest pensioners, or at least those who have managed to build up a significant pension fund at retirement. This LTA (currently £1,055,000) has only recently started to rise with inflation (CPI), having previously been cut three times since its introduction in 2010. Whilst initially it was estimated this LTA cap would only affect around 185,000 individuals, recent figures issued by Royal London suggest that about 290,000 people have already breached this pensions savings limit, and this number is expected to rise to by another 1.25m as more people retire over the next few years.
Lifetime Allowance Charges – what rates apply?
The LTA effectively specifies the amount an individual can hold in total pension savings, before they must pay additional tax on any withdrawal over this limit. These additional tax charges are significant – 55% on amount exceeded if you draw it as a lump sum, and 25% if taken in any other method. This 25% is in addition to normal income tax due on regular annual pension withdrawals.
Whilst the Lifetime Allowance is now increasing with inflation, earnings tend to increase above inflation, and funds in pension savings should, over the long term, also grow faster than inflation. It is therefore inevitable more individuals will be caught over the longer term.
Who may be affected?
The Royal London published the above findings last month, confirming the expected LTA issues, going on to report that of the 290,000 individuals who have already exceeded the LTA, around half are continuing to add to their pension funds, effectively storing up a tax time bomb when they come to withdraw. They also highlight that relatively senior public sector workers with long service are at significant risk of breaching the LTA, due to being members of generous Defined Benefit/Final Salary Schemes, and who now may also have to work to 65 or beyond, rather than to 60. The lifetime allowance restrictions will therefore affect GPs and NHS consultants possibly forcing them to retire early.
How will you know if this affects you?
It can be very difficult for pension savers to predict if they may be in danger of breaching the £1m lifetime allowance cap. It can also very much depend on the type of pension you have, and so for example, as a member of a Defined Benefit scheme, the deemed total fund value is usually determined via a multiple of your expected annual pension. For those who have a personal pension or Defined Contribution scheme, it is simply what the final value of pension savings will be, and given pension savings are usually invested in equities or bonds, predicting the final value can be challenging to say the least.
Potential Tax Mitigation
Those who are close to the lifetime allowance or who have already exceeded this, may still be able to apply to HMRC for a level of protection which may enable them to avoid a tax charge by locking in a higher LTA from an earlier tax year. However, many don’t know that this is available or don’t realise they are at risk of exceeding the allowance.
If you think you may be affected by the LTA limit, and would like to discuss methods to mitigate the potential tax charge, please get in touch with Lynn Gracie, or your usual AAB advisor.