We all know how increasingly important it is to have a good amount of money set aside for retirement. The government encourages this with tax relief on the money you save towards your pension. But, since they have changed the rules, it is possible to end up with a hefty tax bill when it comes to withdrawing your pension later on. It’s worth taking the time now (especially for higher rate tax payers) to make sure that your pension situation is as tax efficient as possible.
We support a number of higher rate tax payers to reclaim tax relief on their private pension contributions and are finding that the lifetime allowance is becoming an issue for an increasing number of pension contributors.
What change to pension rules?
In 2006, the government dramatically reduced the limit on how much you can put into your pension in a single year and during your lifetime (the Lifetime Allowance).
The current limit on how much you can save for your retirement in your lifetime is just over £1m. To put this in context, in 2011-12 this figure was £1.8m.
The penalty for going over this limit is a massive 55% tax on a lump sum withdrawal, or 25% on pension taken as income.
Why has the government introduced this new pension Lifetime Allowance limit?
The huge tax liability on going over the limit really feels like a punishment. Though this is somewhat counter intuitive, as it would sensible to presume that the more individuals who set aside for their retirement, the better for them and the state. When you look at the figures, the reason behind the change in regulation becomes clear. Government tax from pensions is £110m, up from £10m in 2006 before the introduction of the new Lifetime Allowance and corresponding 55% tax on the excess. That’s a 1,000% raise.
Will the pension lifetime allowance affect me?
This depends on your pension projections. Basically, if you are earning £50,000 or more and have a final salary pension, this pension ruling will affect you. This is because final salary pensions are calculated at a multiple of 20, when you hit retirement.
If you have been paying into a pension pot, alongside your employer, over a long career, then it could also affect you. Now that the state pension age is higher, if you started work at 22 and contributed to your pension for your whole career, you could be over the new Lifetime Allowance before you get to retirement age.
Some people are also caught out because they have more than one pension income. You may have a pension coming to you from a job you did years ago and have since forgotten about. The Lifetime Allowance applies to all pension incomes combined, so its’ important that you work out your total.
Director of WEALTH at work, Jonathan Watts-Lay, explains:
“Reaching the LTA could be closer than many employees think. For example, they may have a number of pension schemes that when combined with their current pension provision, could exceed the allowance. The tax implications could be drastic and could lead to potentially many being hit with unexpected and sometimes unnecessary tax bills.Many workplaces now offer support to their employees in terms of financial education, guidance and advice. This approach helps both the employer and the employee by ensuring employees understand all their options before making what could be life-changing decisions, therefore leading to better outcomes.”
What should I do about my pension position?
Firstly, you need to check your annual pension statement from your pension provider to see where you are predicted to be in relation to the allowance limits. Then you need to round up any missing paperwork for forgotten pension schemes you paid into in the past. This government ‘find pension contact details’ is a good place to start if you really have lost all the details.
If you discover that you are going to exceed the Lifetime Allowance limit and you’d rather avoid the 55% tax, you have other options. They depend on a variety of elements, like your age and the options available in your workplace.
- Take early retirement – no more contributions mounting up towards the limit
- Different ways to save – like workplace share schemes and Lifetime ISAs
- Workplace options – some employers enable you to take cash amounts, instead of pension contributions
- Opt-out of workplace pension scheme – but be aware that your employer has to enrol you back onto the scheme after three years
The best thing to do is organise all of your choices in front of you and then do the maths. It may be better to stay in your employer contribution pension scheme, even with the 55% tax bill. Get professional advice if you think you need it and work through each viable option to keep you and your pension as tax efficient as possible.
If you are a higher rate tax payer or a UK non resident paying tax in the UK on your pension income we offer support services to assist in reclaiming any available UK tax relief from your pension income and contributions.
