Pension lifetime allowance (LTA) rules allow people to save up to £1,073,100 into their pensions over a lifetime without facing tax charges and in the March Budget, Rishi Sunak froze it at this level until April 2026. Following this, it has been predicted that an estimated 10,000 individuals with large pension pots will pay more than £22,000 in extra tax by 2024.
On this, WEALTH at work detailed it believed the LTA will typically affect one of three main groups of people.
In highlighting these groups, it hopes to alert people to the fact they may be breaching the LTA and could end up with high tax costs.
Those who are blissfully unaware
WEALTH at work explained: “Most probably think that they aren’t one of the lucky ones to have a pension pot valued at the current LTA limit of £1.07 million 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. Also, many people with defined benefit (DB) pension schemes are unaware that their pension is valued at twenty times their annual pension for LTA purposes, and so an annual pension of £30,000 has a value of £600,000. Also, any tax free cash received from the pension will also need to be added to this figure and checked against the persons available LTA.
“If a member of a DB scheme decides to transfer their pension savings into a defined contribution scheme to take advantage of the pension freedoms, the transfer values offered can be much higher than the standard method of working out the LTA value. For example, transfer values can be as high as forty 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 current LTA.”
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Those who think they are a long way off
WEALTH at work continued: “This group believes that they are a long way from breaching the LTA, but in fact aren’t. This is particularly the case where people 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 before they know it.
Those who think they are protected but aren’t
“Some people who have taken protection measures and opted out of their workplace pension scheme to safeguard their savings from the LTA charge, could still be at risk of a breach,” WEALTH at work added. “This is because of how the rules around auto-enrolment work, meaning that employees are re-enrolled every three years.
“Just one month’s contributions could invalidate protection previously granted, without someone 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, but this may not be the case.”
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Fortunately, WEALTH at work shared the following tips that people can take to either avoid or reduce the impact of the LTA:
- Review current situation – If they have already taken some pension benefits, individuals should start by looking at a current pension valuation and assessing how much of their LTA they have used. If they 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.
- Consider alternative savings vehicles – Individual Savings Accounts and workplace share schemes are two tax-efficient savings vehicles for people to consider saving in as an alternative, or supplementary to a pension.
- Opt-out – Some people 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, people 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 pension scheme despite a potential tax charge. If you are considering opting-out then it’s best that regulated advice is received from a suitably qualified adviser.
- Take early retirement – A simple way for people to avoid exceeding the LTA, or incurring further charges, is to stop contributing into their pension and taking early retirement.
On top of this LTA work, recent research from a Canada Life Survey of 1,013 UK adults aged 55+ revealed that while 14 percent of people have flexibility to access their pensions over the last year, two fifths of all respondents were unaware of restrictions such as the Money Purchase Annual Allowance (MPAA).
The Money Advice Service explains how the MPAA works: “Currently you can pay up to £40,000 a year (or 100 percent of your salary) into a pension scheme and get tax relief on your contributions. This is known as your Annual Allowance. However, if you start to take money from a defined contribution pension, the amount you can pay into a pension and still get tax relief reduces. This is known as the MPAA.”
Exceeding the MPAA can lead to even more tax penalties for unexpecting retirees and as such, Andrew Tully, a Technical Director at Canada Life, called for a review of the rules.
He said: “The Money Purchase Annual Allowance is quite simply penalising people for doing the right thing. Retirement journeys are changing and it is no longer the cliff-edge event it used to be. Many more people are choosing to retire later for a variety of reasons and continue working in older age, either by reducing their hours, setting up their own business or perhaps embarking on a less pressured career.
“Particularly after the financial stresses of the last year, it is understandable that people have chosen to access their pension savings for any number reasons, perhaps to top up their salary under furlough or to make those essential home improvements. This has become an increasingly popular financial decision as more than £40 billion has been withdrawn from pension savings since the inception of pension freedoms in 2015. This continued growth in the number of individuals accessing their pensions implies that we are seeing more and more working people look to their pension pot to manage their expenses or cover unexpected costs. To then limit their ability to add to their pension pot to £4,000 a year is deeply unfair.
“Given the impact Covid-19 is having on our country there is a strong case for reviewing the MPAA, so those who access taxable income from their pension can re-build their savings once this crisis is over. At the very least the MPAA should go back to the previous limit of £10,000, although my preference would be to scrap it altogether. The Treasury may worry about tax leakage, but the much greater issue in my view is the lack of retirement savings which many people have. Scrapping the MPAA removes an unnecessary complex barrier and may help many who were in financial hardship rebuild their retirement savings.”
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