Pension Taxes Begin to Bite!
Our ethos at Chesterton House is to look after the technical stuff so that you can get on with your life. Sometimes, though, it helps to gain a deeper understanding of key issues so that you can make good decisions about them, with or without the help of our Planning Team. In this occasional series of articles, one of our professionals will go into more detail about a topical subject. We hope you enjoy reading them.
In this post, Chesterton House Managing Director and Senior Financial Planner, Richard Urwin, looks into the tax traps that can affect people with higher value pension funds.
In response to a freedom of information request, HM Revenue & Customs confirmed that taxes taken from those whose pensions breach the Lifetime Allowance (LTA) nearly trebled to £110 million in 2016/2017, from £40 million in 2014/2015. The number of people paying Lifetime Allowance tax charges more than doubled from 1,020 to 2,410.
In the April 2006 an overall limit was introduced on the amount of tax privileged
pensions funds an individual can accrue during their lifetime; this was called the 'Lifetime Allowance' (LTA). When first introduced the LTA was set at £1.5 million and it was widely thought at that time that very few people would end up paying this new tax. The limit was raised each year until it peaked at £1.8 million in 2010/11.
Since then, in an effort to balance the books, the Chancellor has cut the allowance in stages to a level of £1 million in 2016/17 & 2017/18. From this point forward it was to be linked to the Consumer Price Index (CPI) and it rose slightly to £1,030,000 for the 2018/19 tax year.
Figures are not yet available for 2017/18 but, given the reductions in the LTA in recent years and the growth in pension funds, it is likely that tax bills will keep rising as will the numbers of savers affected.
As the reporting regime relies to some extent on savers understanding when they have breached the LTA and reporting this themselves to HMRC, it is likely that these numbers understate the total number of people affected.
Many people simply do not know how to calculate the value of their benefits for the purposes of the LTA and when they need to do so.
A client due to retire aged 60 in a couple of years with a modest money purchase pension pot of, say, £250,000 and a reasonable final salary pension projection of £30,000 a year plus a lump sum of £90,000 may be surprised to learn that their total pension benefits are already valued at £940,000 for LTA purposes. This will significantly impact their planning, because without action and with the expectation of future growth in these values, they are highly likely to breach the allowance before they retire.
Those who breach the LTA are taxed at 55% on the amounts exceeding the limits if the excess is taken as a lump sum. If taken as income the rate is 25%, but income tax also applies. These are significant penalties for people who have been prudent and managed their funds well to have to bear at the time when they withdraw their pension funds to live on.
There are steps that can be taken to minimise this tax penalty, for example by crystallising funds early, or considering transferring out of your employer's pension scheme in order to fix the benefits at the current level - although this may mean losing valuable future benefits, so you'll need to understand clearly what you'll be giving up before you make this kind of decision.
The rules around the LTA are complex and it is essential to plan. Pensions are just one form of savings and as always we would suggest that you address this area as part of a holistic approach to financial planning. Planning sensibly to minimise tax is best achieved as part of an ongoing relationship as steps need to be taken consistently over many years and in a timely manner to be effective.
Our aim is to inspire our clients to plan and achieve their goals, get their entire financial house in perfect order, and have a great life, and taking time to properly understand your values, goals and objectives is an essential part of our process. Once you know exactly where you're heading, designing the route to get there becomes much easier.
Written by Richard Urwin, Dip PFS
Managing Director, CHFP