Jonathan Watts-Lay, director of Wealth at Work, considers which individuals are most likely to breech the allowance, and how to plan for it.
Latest figures show that £110 million was collected in tax from individuals exceeding the Lifetime Allowance.
This is the maximum amount of savings which can be saved into a pension and receive tax relief, and the figure has rocketed by £100 million since the limit was first set in 2006.
In the 2006/07 tax year just £10 million was collected from individuals exceeding the Lifetime Allowance – which was £1.5 million at the time. In the 2016/27, with the allowance reduced to £1 million, a whopping £110 million was collected from such individuals.
Typically, those who breach the allowance fall into one of three categories:
The blissfully unaware
Who are these lucky people to have a pension pot valued at the current LTA limit of £1.03 million or more? It is quite possible that the value of someone’s pot is far higher than they realise and that they may have already breached the allowance.
This could particularly affect those who never check the value of their pension or haven’t done so for some time. Many individuals in defined benefit (DB) pension schemes are unaware that their pension is valued at twenty times their annual pension for LTA purposes and so an annual pension of £30,000 has a value of £600,000.
If a member of a DB pension scheme decides to transfer their pension into a defined contribution scheme to take advantage of the pension freedoms, the transfer values offered can be much higher than the standard method of working out the LTA value. For example, transfer values can be as high as forty times the annual pension, so using the above example an annual pension of £30,000 could have a transfer value of £1.2 million and therefore exceed the LTA.
Those who think they are a long way off
This group of individuals believe that they are a long way from breaching the LTA, but in fact aren’t. This is particularly the case where individuals are making healthy contributions into their pension and perhaps receiving valuable matching contributions from their employer. Positive pension fund growth as well as a pay rise may easily push someone over the LTA before they know it.
Let’s use as an example someone aged 45 with a pension fund of £400,000 and a salary of £50,000. If they save 5 per cent of their salary into their pension and their employer contributes 10 per cent, and both contributions increase by 3 per cent a year, it is possible their pension fund will reach £1,67 million by the time they retire at 65.
Those who think they are protected but aren’t
This group of individuals could unknowingly breach the LTA because of the way in which auto-enrolment works.
For example, employees who have taken protection measures and opted out of their workplace pension scheme to safeguard their savings from a LTA charge could still be at risk of a breach. This is because employers are required to re-enrol employees every three years and may do so without their knowledge.
Most employers will inform employees whom they plan to re-enrol, so that they’re aware pension contributions will be deducted from their monthly pay, but it is not a legal requirement for them to do so. Just one month’s contributions could invalidate a previously applied for protection without someone even realising.
For those that could be at risk there are some steps that can be taken to either avoid or reduce the impact of the LTA:
- Find out much LTA has been used
Individuals who have already taken some of their pension should request a current valuation for their pension pot from their employer or pension scheme administrator and ask how much of their LTA they have used. If you have more than one pension, you will need to add up what you have accumulated across all pensions. Individuals are then in the best possible position to choose the most appropriate type of support that they need.
- Ask about workplace support
Some employers may offer cash in lieu of pension contributions for employees who are close to exceeding the LTA. They may also offer financial education or regulated advice to help individuals understand their specific situation.
- Research alternative savings vehicles
Isas and workplace share schemes are two tax-efficient savings vehicles to consider investing in as an alternative, or supplementary to a pension.
Individuals could choose to opt-out of their workplace pension scheme but need to remember that they may be re-enrolled by their employer after three years. Make a note of when this will be and speak to your employer to discuss their options before the three year period arrives.
A decision to opt-out should not be taken lightly. Individuals should remember that the LTA is an allowance, it is not a limit, so it could well be in a member’s best interests to remain active in their pension scheme despite a potential tax charge. If opt-out for LTA purposes is being considered then it’s best to seek regulated advice from a suitably qualified adviser.
- Take early retirement
A simple way to avoid exceeding the LTA, or incurring further charges, is to stop contributing into a pension and taking early retirement.
Jonathan Watts-Lay is director, WEALTH at work, a specialist provider of financial education and guidance in the workplace supported by regulated advice for individuals