During many of our annual planning meetings with clients, we often cover the effects of the pension lifetime allowance, as this now impacts upon more and more people. The pension lifetime allowance is the maximum value you can build up in all pensions without incurring an additional tax charge.
The current level of the Lifetime allowance is £1m and this is scheduled to increase in line with CPI (a measure of inflation) from April 2018. It is estimated that 4% of retirees will exceed this allowance – as there are 11.5 million people approaching retirement age this means 460,000 could be subject to the tax charge by the time they come to draw their pension benefits.
Government figures suggest that tax revenues of £126 million were collected from individuals whose pension pots exceeded the lifetime allowance in 2015/16 and this represented an increase of 62% on the previous year. Importantly, the standard Lifetime Allowance was £1.25m at that time!
It is an allowance not a limit
We prefer our clients not to view the lifetime allowance as a limit but more a point at which the tax treatment changes, so it is no different to other allowances such as the personal income tax allowance or annual capital gains tax allowance.
When your pension fund value is more than £1m you may have to pay tax on the excess slice of your money. It is important to note that you only pay the tax when you start to take pension savings over the £1 million allowance. It is not something you automatically pay when your pension savings reach that figure.
So how much is the tax?
There is a myth around the tax being 55% in all cases; but this is only the case if you take the excess over the lifetime allowance as a lump sum. If you draw the excess as your savings over the allowance as income the tax charge is 25% this being a tax charge on top of the income tax you pay on your pension. So, if you are a 40% tax payer you would pay total tax of 55% on this excess income. This is because for every £1,000 of excess, a £250 lifetime allowance charge is deducted, leaving £750. After 40% income tax that leaves £450, resulting in the same figure as the 55% charge. This is therefore the same rate of tax so it the comes down to bird in the hand or in the bush if you have a choice.
Those in a final salary scheme who have breached the allowance will have no choice other than to pay the 25% lifetime allowance tax charge, and income tax on their pension payments.
It is important that you get advice as to how you are best to take this excess income and using your tax allowances can help to reduce the total tax you pay.
Work out if you are likely to reach the figure
It is important to get to know about all your pensions so you can keep track of what you have. We, as your financial adviser, will review your pensions annually and are able to project whether you are likely to breach the limit.
If you reach the figure are you better off saving elsewhere?
This very much depends on circumstances and we have covered this in a previous blog.
A further check is made at 75.
We also spend some time looking at this when putting together financial models for our clients as there are instances where the lifetime allowance must be paid on any remaining funds. This is once again where a good financial planner will work with you to ensure this is minimised / planned for.
In short, it pays to talk and discuss this issue with your financial adviser who can assist in ensuring your pension fits in with your goals and lifestyle aspirations but trying to ensure taxation is minimised.