Will you be trapped by the lifetime allowance?
Updated: Aug 8, 2019
The overall cap on pension savings could catch out those with modest incomes.
New analysis by Royal London shows more than 1.5 million people are on track to exceed the lifetime allowance on their pension savings*.
Under the current rules, if your pension savings are worth more than £1.055 million, then you have to pay a tax charge of 55% if you take the excess as a lump sum. If you take it as income, for instance as drawdown or by purchasing an annuity, it will be taxed at 25%. This is on top of Income Tax at your marginal rate.
Around 290,000 savers already have pension rights above the limit and well over a million more are at risk of breaching it by the time they retire**.
Almost half of those who are already over the lifetime allowance are continuing to add to their pension wealth, thereby storing up an even bigger tax charge with every passing year.
Rise and fall
When it was introduced in 2006, the LTA stood at £1.5 million. It was then increased each year, reaching £1.8 million by 2010. But since then, successive cuts have put many more savers within range.
The insurer suggests that many senior public sector workers with generous defined benefit pensions are in danger of exceeding the limit – as are better-paid private sector workers with salaries of £60,000 or more.
“This research shows, for the first time, how the drastic cuts in the lifetime allowance mean that large numbers of workers will now be caught by a limit that was originally only designed for the super-rich,” Steve Webb, Director of Policy at Royal London.
“The government needs to think hard about how to make sure people are aware of these limits in time to make alternative arrangements, and individuals need to take expert advice if they are to avoid potentially huge tax bills”.
If you’re closing in on the lifetime allowance, opting out of further pension saving in favour of other investments could make sense. But Tony Clark, a pensions specialist at St. James’s Place, warns against making any knee-jerk reactions.
"Quitting your pension will mean missing out on contributions from your employer, as well as valuable tax relief," he says.
“Even taking into account the tax penalty, it could make sense to carry on saving. A potential lifetime allowance issue shouldn’t always automatically lead to a stop in contributions."
You may also need to consider the needs of younger family members. For instance, it may be better to carry on contributing to your pension if you intend to leave it as a legacy when you die. This is because monies within the pension are outside your estate for Inheritance Tax (IHT) purposes, whereas most other investments count. If the pension pot exceeds the lifetime allowance when you die, then your beneficiaries will have to pay the lifetime allowance charge, but this could be significantly less than paying IHT at 40%.
“Seeking advice is your best option,” says Clark.
The value of an investment with St. James's Place will be directly linked to the performance of the funds selected and may fall as well as rise. You may get back less than the amount invested.
The levels and bases of taxation, and reliefs from taxation, can change at any time and are dependent on individual circumstances.
*/** The Lifetime Allowance timebomb, Royal London, 24 March 2019. The research is based on detailed analysis of data on more than 7,700 workers from Wave 1 and Wave 5 of the ‘Wealth and Assets Survey’.
DWB Wealth Consultancy LLP