In April, the lifetime allowance (LTA) drops to £1M and for anyone approaching this limit there are some tough choices ahead:
- Should I continue to pay pension contributions?
- Should I give up the pension contributions from my employer?
- If I exceed the LTA, is it worth carrying on paying into a pension?
How this could affect you depends on your circumstances, if you would like to speak to us about this, please give us a call.
Everyone’s initial reaction will be to stop paying into their pension as this will lead to a tax charge on savings in excess of the LTA. However, is a bigger tax bill necessarily a bad thing?
So what must you consider when making this important decision?
|✔ You’ll reduce or eliminate the LTA charge on future savings.
✔ You’ll potentially be eligible for ‘fixed protection’ on your existing savings.
|✔ You’ll continue to benefit from your employer’s contribution.
✔ You’ll still get tax relief on their personal contributions at your highest marginal rate of income tax (if within your annual allowance).
✔ The pension will continue to grow tax free.
|✘ You’re likely to lose your employer’s contributions.
✘ You’ll have to decide where to save your personal contributions instead.
|✘ Saving above the LTA will be subject to an LTA charge of 25% if savings extracted as taxable income (or 55% if the surplus is taken as a lump sum).
✘ None of the surplus can be taken as tax free cash.
Fixed protection could mean that up to an additional £250,000 of your pension funds are free from the LTA charge, but just a single pound of additional contributions will void that protection. So it’s clear that there’s a trade-off of an increased LTA against the loss of future funding.
The loss of employer funding
Employer pension contributions are essentially ‘free money’. Even if you suffer an LTA charge of 55% on your entire future employer funding you’ll still be better off (As you’re still receiving 45% of something they would otherwise miss out on).
If you have to continue to pay into the scheme in order to secure the employer contribution, it could still make sense and take the LTA charge on the chin.
The goalposts may move if your employer is prepared to offer some other financial incentive instead of making pension contributions. This will very much depend on what the alternative offer is, and how much will be lost to tax and NICs (both individual and company), but is worth considering.
So I have decided to stop paying into a pension, where do I save for the future now?
- National Savings
- Offshore Bond
But wait – why not continue to fund your pension?
Funding above the LTA certainly makes sense where it means retaining employer contributions (‘free money’), but the same can be said for personal contributions too!
There’s something that feels slightly uncomfortable about paying contributions knowing that an additional tax charge will be applied, but what really matters is what you get back after all taxes have been deducted.
The table below compares what you could get back after 10 years for the same net cost of £15,000:
|Contributions paid (inc tax relief)
|Final fund value
(10 years later assuming 2.5% growth pa)
|LTA charge 25%
|Income tax 20%
|Net amount received
What this does ignore is the position on death; the pension is generally IHT free, whereas both the ISA and offshore bond will form part of your estate for IHT.
It’s only natural to think tax charges should be avoided – especially one designed to act as a cap on funding, but it’s always important to weigh up all of the options available.
If you would like to weigh up your options and the alternatives, please call us for a chat.