The government, wary of the ever-larger cost of providing for an increasing growing older population, is very keen on people contributing to personal pensions to fund their retirement.
The more of us prepare for retirement by building up a pension pot, and the bigger we make that pot, the less will be the demand on the exchequer for state pensions.
So the government has provided some very attractive allowances to help us build our pensions.
Putting a pound in a pension, costs just 80p for basic rate taxpayers, and 60p for higher rate taxpayers. Saving into a pension is probably the most tax efficient investment the majority of us will ever make. The contribution from the taxman means we will have already made money as soon as our savings reach our pension provider.
The Lifetime Allowance is the maximum a person can save into a pension without incurring a tax charge. It currently stands at £1,073,100 and has been frozen until the 2025/26 tax year. This sounds a great deal of money, but it is significantly lower than its peak of £1,800,000 back in 2011/12 – and for some people it can be surprisingly easy to reach.
Spend a few decades saving into a pension plan at something close to the annual limit of £40,000, per year and you could find that your pension pot has gone past the current lifetime allowance limit.
This means that you could find yourself facing a tax charge of 55% as the taxman claws back the contribution he has made to your pension savings, and more besides.
It is a growing problem, and you may need to act now to ensure you are not caught by this tax charge, if you are nearing this limit
The levels and bases and reliefs of taxation are subject to change, and depend on individual circumstances
Why many more of us will be caught by the charge
Not exceeding the lifetime allowance ought to be easy enough. Simply don’t put too much into your pension pot. But in practice things are not so simple.
Inflation may be forcing down the buying power of cash, but the value of investments can be forced up by inflationary pressures. A pension pot which is well within a lifetime allowance now could easily grow past it.
Factor in higher contributions as wage inflation swells take home pay, and astute pension savers pay more into their pension funds to avoid tax, and it’s easy to see that more and more people may be caught out.
There are signs that this is already happening. Figures from HMRC showed that 8,500 pension savers fell foul of their Lifetime Allowance in the 2019/20 financial year, a 21% increase from 2018/19. It is a trend that looks set to continue.
How to avoid the taxman raiding your pension
Your lifetime pension savings are generally checked when you draw your pension, reach the age of 75, or on death. If you have breached your allowance at any of those points, the taxman will be helping himself.
You need to ensure that you are not in danger of passing the £1,073,100 threshold at any point in the future.
This can be more complicated than it appears. Understanding the growth potential of an investment and its potential yield tens of years in the future may need an expert eye. The tax rules about the Lifetime Allowance are complex and professional retirement planning advice could be crucial to keeping the cash you have worked hard to build up.
At Continuum we have the expertise to help. We can help you look at your existing pension plans and provide a long-term forecast.
This means that if you are in danger of going past your lifetime allowance it will be much easier to change the direction of your pension saving – as well as showing you if there is any danger of a pension shortfall.
If we detect problems ahead, we can help you find alternative ways to prepare for retirement. Diverting some of the excess funds you had earmarked for your pension pot into suitable investments such as ISAs will let you build the pension funds you want without having to share them with the taxman.
To get the help you need, simply contact us at Continuum.
The value of an investment and income from it can go down as well as up. When investing capital is at risk
The information contained in this article is based on the opinion of Continuum and does not constitute financial advice or a recommendation to suitable retirement investment strategy, you should seek independent financial advice before embarking on any course of action.