Middle-class savers are now being caught by lifetime allowance stealth tax

Exceeding the lifetime allowance results in heavy tax charges when accessing your pension.

One million workers are at risk of breaching the pensions lifetime allowance limit, triggering hefty taxes, research from the mutual insurer Royal London shows.

According to the research, just under 300,000 non-retired people already have pension pots worth more than the current £1.03 million lifetime allowance limit. An estimated £1.25 million more workers are expected to join them by the time they retire.

Exceeding the lifetime allowance results in heavy tax charges when accessing your pension. Pensioners are currently changed up to 55% of their pension for any amount that exceeds the £1.03 million limit.

According to Royal London, there are two key demographics most likely to breach the limit. First of all, senior public sector workers with long service. Many of these workers (although not those in their twenties or thirties) will be in defined benefit or final salary schemes that will exceed the lifetime allowance, especially now if they have to work until the age of 65 rather than 60.

The second group are relatively well-paid private sector workers in defined contribution schemes with employers that generously match contributions. The typically salary range for such employees is between £60,000 and £90,000.

Royal London’s research also reveals that those already in breach of the lifetime allowance limit are continuing to add to their pension pot, despite the 55% tax charge. 

The lifetime allowance has been controversial since its introduction in 2006 by former chancellor Gordon Brown. When first introduced, the limit was placed at £1.8 million. However, from 2010, the amount was steady reduced, reaching £1 million in 2016.

Since then the lifetime allowance has gone up slightly, to its current level of £1.03 million. However the increase has been the result of government policy to up the limit in line with inflation.

While any increase is more welcome than none, most saving for their pension invest with the hope of growing their pot above the rate of inflation. Those that achieve this will move closer and close to breaching the limit.

It is for this reason that the lifetime allowance is seen as a tax of successful investing, penalising those who have successfully invested and grown their pension pot. 

According to Steve Webb, director of policy at Royal London: “The government needs to think hard about how to make sure people are aware of these limits in time to make alternative arrangements, and individuals need to take expert advice if they are to avoid potentially huge tax bills.”

From 6 April, the start of the new tax year, the lifetime allowance will rise in line with inflation to £1,055,000.

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