Pensions have become a lot more interesting in recent years: new pension rules that give you flexibility in the way you access your pension savings have provided exciting new opportunities for how you spend the pot you’ve built up.
As a result, more of us are using pensions as a tax-efficient way of saving for the future. It’s all good news for our incomes in later life, but there could be a flip side to the fact that we’re saving more:
It’s called the LTA…
The Lifetime Allowance for Pensions (LTA) is the amount that you can have in pension benefits without incurring additional tax charges. The LTA started life in 2006 at £1.5 million and peaked at £1.8 million in 2010, but its value has been cut by successive Chancellors since then. Most recently, in April 2016, it was cut from £1.25 million to £1 million.
Now £1 million saved in your pension fund sounds like a lot, and it’s certainly not an insubstantial sum. But considering you could be relying on your retirement pot for decades, it’s actually not a ridiculous figure to aim for. As a quick example, if you were to retire at age 65 and withdraw an average of 4% a year from your £1 million pension fund, your annual income from your pension would be just over £36,000 after tax – which suddenly doesn’t sound quite so much, and could be a reason to keep on saving.
And ‘keeping on saving’ is exactly what it looks like many Brits are doing, despite the LTA. According to data from HMRC, tax revenues from the LTA charge have risen by 80% in the last year. Now if this is due to people being caught unawares, it could result in the nasty surprise of an unexpected tax charge. However, if proper planning has been done, and people are still choosing to save over and above their allowance, it shows that more and more people are identifying that they still have a need to save for retirement, and are realising that the LTA is not an absolute limit.
What’s the damage?
If your pension pot exceeds the LTA when you come to take benefits from it, there is additional tax charge to pay on the amount over the allowance. How much that tax is will depend on how you take the money. If you take it as a lump sum, then the tax is 55%. However if you take your money as income, then the tax charge is reduced to 25%, plus any income tax due.
I understand that these figures can sound like a lot, but the tax advantages of saving into a pension can balance things out, meaning that alternative options are often not really any more attractive.
When do I pay it?
It’s really important to realise that you don’t pay the tax charge when your fund value tops the allowance figure. You will only pay the charge as and when you take that surplus in the form of pension benefits. So you don’t pay it until after you’ve taken the LTA amount in benefits.
What if I don’t spend all my pension?
It’s important to remember that you can leave any unused pension savings to your heirs and it won’t count towards a potential Inheritance Tax bill. But remember there will be a possible LTA charge at age 75 from any pension funds you haven’t started to take an income from. And if you die before your 75th birthday there may an LTA charge on your death benefits.
Pensions are an important element of estate planning, so talk to an 1825 Financial Planner about using your fund to benefit your heirs.
How do I know if my Pension Fund will be too big?
Your 1825 financial planner can map it out for you. We can give you examples of how your fund will grow depending on market performance and on the level of your contributions. We can then show you what the tax implications might be.
Aaaagh! My Fund is already too big!
As Captain Mainwaring would say: “Don’t panic!” Remember that even if you end up paying an LTA tax charge on some of your fund, if you take it as income you’ll still have 75% of what you’ve built up over £1 million left to spend (subject to income tax, of course).
If your pension fund is already over £1 million, but is less than the previous LTA of £1.25 million, then there may be ways to protect the amount you’ve already built up and not pay an LTA tax charge on the excess. It’s called “Fixed Protection 2016” and to qualify you mustn’t have put anything into you pension since 5 April 2016. This may leave you with excess income to invest elsewhere, so remember that if it doesn’t go into your pension, it will normally be subject to income tax and National Insurance. Talk to your 1825 Financial Planner if this is you.
So should I stop putting money into my Pension when it hits the £1 million mark?
That’s a really good question – and the answer is “Probably not” – unless you have registered for protection and risk losing it. Although to be honest, the real answer is “It depends”, because what’s right for you will depend on a whole host of factors that are personal to you. That’s why it’s helpful to speak to a financial planner who understands your situation.
That being said, there are a number of good reasons to carry on putting money into your pension fund, even if it is going to top the LTA:
1. If you’re employed and entitled to be in your employer’s workplace scheme, then stopping contributions may mean that you lose out on the contributions your employer will put into your pot. Even if you later pay an LTA tax charge on the value of those contributions, the remainder is still money that you wouldn’t have had if you’d stopped contributing yourself.
2. If you’re a higher or additional rate taxpayer, the tax relief you get on your contributions now will be at 40 or 45%. If you take your surplus pension as income later in retirement when you’re a basic rate taxpayer, you’ll pay an LTA tax charge of 25% plus income tax at 20% (but only on the excess). But in the meantime, all the growth on your contributions has been added to the pot free of tax.
3. If you have pension money left in the pot when you die, it usually won’t be considered as part of your estate for Inheritance Tax purposes.
4. The LTA is going to increase over time. The Government has committed to increase the LTA in line with inflation, so by the time you take your benefits, the LTA will almost certainly be higher.
It’s important to remember that the LTA isn’t a limit: you can continue to save in your pension with all its advantageous tax treatment of any growth or returns even if your fund exceeds the allowance.
But it is critical to plan carefully to understand what the tax implications will be if and when you come to take the excess. Your 1825 Financial Planner can help you decide the right course of action for your circumstances, and work with you to optimise your pension opportunities.
If you have any questions about what you’ve read here, please don’t hesitate to get in touch. You can reach us on Twitter or Facebook, leave a comment for me below, or book an initial meeting with one of our financial planners.
This blog and any responses to comments should not be regarded as financial advice. Laws and tax rules may change in the future and your tax treatment is based on your individual circumstances. The information here is based on our understanding in August 2017. Investments can go down as well as up in value and you may get back less than you pay in.