How employees can reduce the impact of the LTA on their retirement nest-egg
However despite this, many employees don’t even realise that they are at risk. WEALTH at work has identified those employees it thinks may be affected the most. This includes:
1. Those who are unaware
Most people probably think they aren’t one of the lucky ones to have a pension pot valued at the current LTA limit or more – but it’s quite possible that the value of their pot is far higher than they realise and they may have already breached the allowance.
This could particularly affect those who never check the value of their pension, or haven’t done so for some time. And many employees in defined benefit (DB) pension schemes don’t realise that their pot is valued at 20 times their annual pension for LTA purposes, so that an annual pension of £30,000 has a value of £600,000.
Further to this, any tax-free cash received from the pension will need to be added to this figure and tested against the member’s available LTA .
If a member of a DB scheme decides to transfer the arrangement into a defined contribution (DC) scheme to take advantage of the pension freedoms, the transfer values offered can be much higher than the 20 times multiple used for working out the LTA value. For example, transfer values can be as high as 40 times the annual pension, and so, using the above example, an annual pension of £30,000 could have a transfer value of £1.2m and therefore exceed the LTA.
2. Those who are closer than they realise
This group of individuals believe that they are a long way from breaching the LTA, but in fact aren’t. This is particularly the case where employees are making healthy contributions into their scheme and perhaps receiving matching contributions. Positive pension fund growth as well as a pay rise may easily push them over the LTA edge before they know it.
For example*, if someone aged 45 has a pension fund of £400,000 and a salary of £50,000, saves 5% of their salary into their pension, which rises by 3% pa, and receives employer contributions of 10%, it is possible for their pension fund to reach £1,381,000 by the time they retire at 65. With the LTA presently frozen until April 2026, they could easily exceed the allowance by retirement.
*Assumes growth rate of 5% and excludes charges on the pension plans.
3. Those who think they are protected but aren’t
Employees who have opted out of their workplace pension scheme to safeguard their savings from a LTA charge could still be at risk of a breach. This is because under the rules around auto-enrolment, employees are re-enrolled every three years.
Just one month’s contribution could invalidate protection previously granted, without employees even realising. Responsible employers will inform employees whom they plan to re-enrol, so that they’re aware that pension contributions will be deducted from their monthly pay.
Steps employees can take to either avoid or reduce the impact of the LTA:
1 Review their current situation - If they have already taken some pension benefits, they should start by looking at a current pension valuation and assessing how much of their LTA they have used. If employees have more than one pension, they will need to add up what they’ve accumulated across all their pensions to work out the full amount.
2. Consider alternative savings vehicles - Individual Savings Accounts and workplace share schemes are two tax-efficient savings vehicles for employees to consider saving with as an alternative, or supplementary to a pension.
3. Opt-out - Some employees may choose to opt out of their workplace pension scheme for LTA purposes especially if their employer is offering cash in lieu of the employer pension contribution. Also, employees need to understand that a decision to opt out should not be taken lightly and that it could well be in their best interests to remain active in their scheme despite a potential tax charge. If employees are considering opting-out then it’s best they get regulated advice from a qualified adviser.
4. Take early retirement - A simple way for employees to avoid exceeding the LTA, or incurring further charges, is to stop contributing into their pension and take early retirement. Again, it’s important to consider the options available and it may be beneficial to seek regulated financial advice. While having over £1m in pension savings may seem unrealistic to most, reaching the LTA could be closer than many employees think. And it’s not just high earners and those with defined benefit schemes who will be affected, but those who have saved from an early age, and whose investments have performed well. The tax implications could be drastic and potentially lead to many being hit with unexpected and sometimes unnecessary tax bills.
Many workplaces offer support to employees in terms of financial education, guidance and regulated financial advice. This approach helps employees understand all their options before making what could be life-changing decisions, leading to better outcomes for all.
The author is Jonathan Watts-Lay, director at WEALTH at work
This article is provided by WEALTH at work
In partnership with WEALTH at work
WEALTH at work is a leading financial wellbeing and retirement specialist - helping those in the workplace to improve their financial future.
