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07 Dec 2016
by Jeanette Makings

A whale, a cash heist, a tornado and the lifetime allowance

A whale is found in the River Thames. The largest cash robbery in UK history takes place in Kent. London is hit by a tornado.

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Have you guessed the year yet? It was a whole decade ago, in 2006.

Most of us will have forgotten the unlikely mammal in the river, high winds and a £53m heist. But the effect of other changes made that year are now really beginning to bite.

It was also the year that the government introduced a raft of pension reforms (sound familiar?), collectively known as ‘pension simplification’. One of the key changes in 2006 was the introduction of the life time allowance (LTA) and annual allowance (AA).

In 2006, the LTA – a limit on the total value of a person’s pension savings that qualify for favourable tax relief -  was £1.5m. It peaked at £1.8m in 2010, before shrinking to its current low point of £1m for 2016.

Seems a lot?

An allowance of £1m might still sound like a lot of money, particularly when compared to savers putting aside 2% of earnings through auto-enrolment. For high and even mid-range earners, however, £1m in pension savings over a working lifetime is remarkably straightforward to breach. All defined benefit (DB) as well as defined contribution (DC) pensions are taken into account – as are death in service benefits.

The tax penalties for breaching the LTA are substantial. Under the current regime, there’s a 45% rate for funds taken as income (via drawdown, for example), and a 55% charge on cash lump sums. 

For the 2015/16 year, HMRC collected £126m in tax from pension holders who exceeded the lifetime allowance (LTA). The previous year, that figure was £78m. From the Treasury’s perspective, those figures might make LTA look like a success – but they will be less so for those on the receiving end of the tax bills. 

Ensure staff are aware

Given the potentially punitive levels of tax that could now be incurred on what should be a good news workplace benefit, it’s in the interests of employers as well as employees to make sure staff are aware of the allowance limits, how to protect their existing savings, and how best to manage their savings to keep tax bills to a minimum. 

To date, that support has been patchy. Research by Portus Consulting, released in October 2016, found that 45% of the HR departments it surveyed had had to deal with enquiries about the LTA. The same survey showed that 67% of respondents had received questions about pensions tax relief more broadly. That shows the scale of the problem – but is the HR department really the best equipped to deal with it?

Separate research by Punter Southall Aspire showed that a third of financial services businesses had not provided any flexibility for employees when it came to helping them plan their savings and avoid being hit hard by tax bills. And even amongst those that had considered the effect of the limits, the approaches to helping employers were restricted to solutions such as capping the limit of annual pension contributions across the company.

The equally blunt instrument of simply stopping payments into a pension is no guarantee that an employee won’t breach the limit, either. Over time, revenue from investment growth could still push pension savings into the hands of HMRC, even if an employee is no longer actively paying contributions.

The next decade is unlikely to be any easier when it comes to pension tax relief, either in relation to the LTA or for the AA – the amount that you are able to save into your pension tax free each year. The recent Autumn Statement might have been relatively quiet for pensions – but that doesn’t mean we won’t see changes in the longer term.

Employees need education and advice throughout their working lives, to ensure that can manage their retirement savings as effectively as possible. Helping them to understand how much their pension is worth to date, what other options they may have and how best to make tax-efficient decisions is as crucial as offering a good quality pension in the first place.

Jeanette Makings is head of financial education at Close Brothers.

This article was supplied by Close Brothers.

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