How to manage retirement savings for staff who have reached the pensions lifetime allowance
For a number of years now, in fact since 2011/12 when it was £1.8 million I have been writing about the steep reduction in the Lifetime Allowance (LTA) to its current level of just over £1,000,000. Thankfully, there is a small reprieve: the Government announced in the recent Budget an annual increase equal to CPI and the LTA is now £1,030,000 and rising to £1,055,000 in the 2019/20 tax year. This is better than was originally anticipated as a result of higher than expected inflation. However, it’s unlikely to make a real difference to pension savers who are affected by the LTA, because most asset prices have been growing at a rate faster than inflation.
Anyone who has previously opted for LTA protection (be it Enhanced, Primary, Fixed or Individual) is unlikely to benefit from the increase, as it’s only the standard LTA that increases.
Your pension benefits are tested against the LTA when you start to draw them from the scheme. If your total pension savings exceed the LTA at retirement, you will face a punitive tax charge on the excess. This is 55 per cent if you take the money as a lump sum or 25 per cent if you take it as income.
A defined contribution (DC) scheme, in which your end pension depends on the amount of contributions and how they are invested, should give you a current valuation for transfer purposes and an indication of what it will be worth when you retire.
A defined benefit (DB) scheme that provides a pension based on a formula related to your salary, needs to take the anticipated pension income (which should be in your paperwork) and multiply by 20 to roughly work out the LTA test value. So a pension income of £50,000 per annum would have a value of £1,000,000 for LTA test purposes. If you are already near this figure there are a number of ways you can mitigate the potential tax payable, this comes in the form of fixed or individual protection 2016 (known as FP16 and IP16).
Fixed protection enables you to maintain an LTA of £1.25 million and is available to everyone. However, while FP16 is theoretically still available, in order to secure this limit, you are not able to have made any further contributions after 5 April 2016. If you have paid in money since this date, you will no longer be eligible.
Individual protection, meanwhile, is available to those whose pension benefits exceeded £1 million at the end of the tax year on 5 April 2016, but want to continue contributing. For those who qualify, their LTA will be set at the value of their pension benefits on 5 April 2016, subject to a maximum of £1.25 million. Unlike fixed protection, those who apply for individual protection will be able to continue to make pension funding in the future.
Some people in final salary schemes may use the LTA as an excuse to retire early. Members can typically expect to see their annual pension reduce by 5 per cent for every year they knock off their working life. Retiring early can therefore be a legitimate planning tool.
Opting out of your pension scheme may make less sense if you have many years before you retire. However tough a 55 per cent tax charge might be to swallow, some advisers point out that it might be worth accumulating a bigger pension and simply paying the charge – particularly if you’re a higher-rate taxpayer and your employer makes generous contributions on your behalf. You can also pay the tax charge via the scheme funds if this option is made available by the Trustees.
Once you have reached the LTA, there are other ways to save tax effectively. The first calling point would probably be an individual savings account (ISA). This tax year you can invest £20,000 into an ISA, while a couple between them can shelter £40,000 tax free. Those who have already exhausted their ISA allowances could consider a venture capital trust (VCT) or enterprise investment scheme (EIS).
Finally, and subject to contribution limits, topping up your spouse’s pension may also be an option. Putting money away for a non-earning spouse gets you tax relief on the way in. If the income in retirement is less than the personal allowance, it may mean no tax is paid on the way out either.
Educating yourself and obtaining guidance will help you understand your options however as this can be a complex area it may be worth talking to your financial planner to obtain a recommendation on how to proceed.
The author is Richard A Williams APFS, director and head of pension decision service at JLT Employee Benefits.
This article is provided by JLT Employee Benefits.
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