Pensions……there are rules aren’t there? There certainly are and it’s quite likely those rules, to some extent at least, put people off from embracing pensions and using them as a financial planning tool to the fullest extent.
One rule that might be on your radar is the concept of a lifetime allowance (LTA) – it’s not a cap, but it is the point at which you cease to enjoy some of the tax benefits of a pension scheme. At the time of writing, the LTA is £1,073,100. The Chancellor has also frozen this allowance until the 2025/26 tax year.
What does it apply to?
It applies to all of your pensions, with the exception of the state pension.
Isn’t £1m a bit aspirational?
Yes, but it’s possible that you have a defined benefit (DB – aka final salary) pension alongside a defined contribution (where you have a pot of money) and with investment growth, it might be closer than you think.
When should I think about it?
I would argue you crack on with saving into your pensions to the extent that you can afford. You’ll receive tax relief as you save and it’s only tested at certain events. There is a prescribed list, but most commonly it would be when you first decide to access your pension and then when you reach age 75 – irrespective of how you’ve accessed pensions to date.
If you have a DB pension, when you start taking benefits, a calculation is performed to ascertain the effective value of the pension you will be receiving. This again is measured against that £1,073,100 LTA.
Will I have to pay an LTA tax charge?
As often is the case in personal finance, it depends.
For example, if you have a DB pension paying £30,000 per year, it would have a LTA value of £600,000 (55.91%). If that’s your only pension, then you’re home & dry from an LTA tax perspective.
If you have a DC pension of £600,000, the same applies.
Effectively, you can have £1,073,100 of pensions without paying an LTA charge. It’s only when you breach that value, and an event occurs, that you may have to pay. For example…..
You have £1,200,000 in a pension. A nice place to be. You could decide to designate £400,000 initially into drawdown, giving you a £100,000 tax free lump. This utilises 37.27% of the LTA. You could do this again, taking 37.27% of your LTA, meaning you’ve used 74.54%. You then have £273,211 (at today’s LTA value) to utilise your LTA.
You’ve received £268,303 of tax free cash! That’s surely worth thinking about your pension strategy???
What can I do about it?
Well, not too much, unless you had a £1m+ pension pot at 5th April 2016 – if you did, there are options to claim a greater LTA, but again, rules apply and it might not be appropriate to cease saving into a pension just to save some LTA tax.
Don’t forget about your ISA allowances (£20,000 per tax year, per adult) and you could consider investing through a General Investment Account (i.e. an account with no specific tax benefits) – remember, each adult has a £2,000 dividend allowance and a £12,300 capital gains tax allowance, meaning there are some tax allowances you can utilise, outside of normal pension and ISAs.
If you’re married or in a civil partnership, why not contribute into your spouses pension? You both have the same LTA after all…..
So, what do I need to know?
- The allowance is £1,073,100.
- The values of all pensions count, bar the state pension
- Your pension values are tested against the LTA when you access them, or when you turn 75
- Don’t let the tax tail, wag the savings dog
That all being said even with the limit it sometimes makes sense to ignore this and continue saving – for example, is your employer contributing to your pension? Free money – why give that up, even if there’s a tax to pay one day……..
Thanks for reading and