Having too much money is a problem most of us don’t expect to have. However, growing numbers of people are doing exactly that – by having too much built up in their pension pot and exceeding the government imposed lifetime allowance.
This can prove expensive. There are some painful tax penalties for those who are found to have put too much away – and it is becoming ever easier to do so without knowing it.
At Continuum we are looking at what you can do if your pension pot exceeds the Lifetime Allowance.
What exactly is the problem?
The government, aware of the ever increasing cost of providing state pensions for a growing older population, is keen on people saving into personal pensions to fund their retirement themselves.
So keen, in fact, a pension can be the most rewarding investment most of us will ever make. Generous tax relief means a pound in a pension costs basic rate taxpayers just 80p, and higher rate taxpayers 60p. We make money as soon as our savings reach our pension provider.
Professional investment advice coupled with the potential for compound growth can go to work to get our pension wealth growing.
The problem is that pension saving is so rewarding we might plan on putting every penny we make into our pensions, costing the exchequer a fortune in tax relief. The government has therefore set a limit on the amount we can put in.
The Lifetime Allowance currently stands at £1,073,100 and has been frozen until the 2025/26 tax year. Go past the limit, and you could find yourself facing a tax charge as the taxman claws back the contribution he has made to your pension savings. For example, if your pension pot totals £1,300,000 the excess is £226,900. This is taxed at either 55% (if you take it as a lump sum) or 25% if you take it any other way.
Will you go through the allowance ceiling?
£1,073,100 sounds a great deal of money, but if you spend a few decades saving into a pension plan at something close to the annual allowance of £40,000 and have some good luck with investments, it is possible to build up that kind of pot.
Even if you put the brakes on your pension contributions when you think you might be getting close to the limit, 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. Figures from HMRC showed that 8,500 people went past their Lifetime Allowance in the 2019/20 financial year, a 21% increase from 2018/19. It is a trend that looks set to continue.
Fortunately, tax isn’t due when your pension fund values exceed Lifetime Allowance. This is where things become complicated. It’s only payable when your pension is tested at what the taxman has dubbed a Lifetime Allowance Benefit Crystallisation Event, of which there are no less than 13. These fall into three groups, including:
- When you first start drawing a pension
- When you reach 75
- When you die
You’ll face a Lifetime Allowance test each time you access your pension benefits in stages, and when you draw benefits from other pension plans.
So what can you do?
But all is not lost. In some circumstances you may be able to protect your lifetime allowance. Over the last few years, the lifetime allowance has been cut several times from its high point of £1.8m. Every time it has been cut, the government has – perhaps reluctantly – allowed savers to ‘protect’ their pension at the level of the previous higher allowance if their pension savings were more than the new lower allowance.
So, by looking back at your pension history, there may be opportunities to take advantage of schemes – Individual, Fixed or Enhanced protection – to mitigate the tax lost.
However, the legislation around these schemes is complicated, using the schemes is not for the faint hearted, and getting expert advice to take advantage of these schemes is essential. You may need to change your pension plans – in most cases you will not be able to put more into your pension pot. You will probably have to look at your other investments, which may not be as tax efficient.
We can help you look at your existing pension plans and help determine if you are in any danger of going past your Lifetime Allowance. If you have not already done so we can help you understand the protection schemes and see which are most appropriate for you.
We can also help you find alternative ways to prepare for retirement.
To get the help you need, simply contact us at Continuum.
A pension is a long term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Pension income could also be affected by interest rates at the time benefits are taken.
The tax treatment of pensions in general and tax implications of pension withdrawals will be based on individual circumstances, tax legislation and regulation, which are subject to change in the future.
The value of an investment can go down as well as up, when investing your 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 strategy, you should seek independent financial advice before embarking on any course of action.