Mind your step
Lifetime allowance breaches cost pension savers £110 million in a single year.
Tax charges for breaching the lifetime allowance (LTA) on pension savings have nearly tripled over two years as successive cuts to the allowance have taken hold. Figures obtained through a Freedom of Information investigation show that the tax collected jumped from £40 million in 2014/15 to £110 million in 2016/17. The number of people caught out more than doubled from 1,020 to 2,410 over the same period.1
The LTA is an overall limit on the amount you can take from your pension schemes over your lifetime – whether lump sums or retirement income – without triggering an extra tax charge. It applies to all your pension schemes, including your personal pensions and any final salary pension schemes you belong to, but excludes your State Pension. Those who breach the LTA are hit with a potential tax charge of 55% on the amount that exceeds the limit.
The LTA was set at £1.8 million in 2010/11, but successive governments had whittled it down to £1 million by April 2017. Today the limit stands at £1.03 million and is set to rise in line with inflation in future years.
Despite the recent rise, there has still been a 43% cut in the LTA over the past eight years. Consequently, swathes of investors are now in range, particularly those who have built up significant pensions through a combination of a high salary and long service. Many doctors, head teachers, civil servants and middle managers – to give a few examples – are affected.
There are growing calls for the LTA to be abolished, given that the total amount that can be invested into a pension each year – including contributions from employers – is already limited to £40,000, and much less in some cases, via the annual allowance. Dr Ros Altmann, who served under David Cameron as Minister of State for Pensions, has even labelled it "illogical".
“If annual contributions are capped, then arbitrarily limiting the total fund that can be built up over the years amounts to a penalty on good investment performance. It goes against the whole ethos of long-term investing,” says the former minister.
But despite the chorus of criticism, the government has shown no sign of abolishing this potentially costly pensions trap.
If you are at risk of breaching the LTA, then you may wish to stop making pension contributions and look at alternative ways to fund retirement. The annual ISA allowance of £20,000 is not only an obvious alternative to those approaching their annual and lifetime pension allowances, but it can provide a flexible tax-free income in retirement.
Individuals who have maximised their ISA allowance may wish to consider Venture Capital Trusts and Enterprise Investment Schemes – both of which offer upfront tax relief. However, investments like these are only suitable for those who are prepared to accept a significant level of investment risk – and potentially loss of capital.
The rules, reliefs and allowances often change, meaning getting good advice is crucial. Indeed, it would be wrong to rush into making any decisions without first seeking advice from a financial expert.
“If you have significant sums in pensions and believe you have a lifetime allowance problem, then this is where taking professional advice can really add value.” says Ian Price, divisional director at St. James’s Place.
“The best solution could vary widely depending on your circumstances. For instance, stopping contributions to your workplace pension scheme may not be beneficial because you could end up missing out on valuable contributions made by your employer.”
“If those contributions are generous, then staying in the pension scheme and accepting a 55% charge to retain at least some of the value of those contributions may actually make sense. After all, 45% of something is better than nothing.”
“Only by seeking financial advice will you have the reassurance of knowing that you have explored all your options and are maximising reliefs and allowances, while minimising any potential future tax bill,” says Price.
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.
1 Old Mutual Wealth, 2018