Pensioners hit by allowance freeze
The chancellor has quietly announced that the pension lifetime allowance will be frozen at £1.8 million for five years from 2010/11 – a measure that could penalise an individual by as much as £275,000.
As Alistair Darling rattled through boosting the state pension and slashing VAT, he also revealed another pensions decision in a ‘blink and you’d miss it’ short sentence.
The lifetime allowance, which came in in April 2006, provides an overall cap on tax-relieved pension savings, and if your pensions add up to more than the allowance, the excess will be taxed at 55%.
It was initially set at £1.5 million in 2006-07, rising each year to £1.8 million by 2010-11.
But Darling has now frozen the lifetime allowance from 2010/11 to 2015/16. The annual allowance will also be held constant at £255,000.
The measures will save the exchequer millions of pounds; it will save £35 million in 2008/09 when the annual allowance is frozen, increasing to £400 million in 2011/12.
Billy Mackay, marketing director at pension company AJ Bell, says he views the decision as "positive news that the allowances have not been reduced".
However, Malcolm Cuthbert, managing director of financial planning at Killik & Co, warns the announcement could rob an individual of £275,000.
"An individual with £1.8 million in 2010 could retire with no tax penalty, however, if their fund grew by 5% to 2015 and then they retire, their fund would have grown to £2.3 million and therefore they would have to pay 55% tax on the £500,000 excess above £1.8 million which equates to £275,000," he explains.
For Raj Mody, a partner at PricewaterhouseCoopers, the government had given "ample notice" of its intentions for the allowance and hinted that it would have been foolish to assume that just because there are five successive increases to the allowance, the rises would continue beyond 2010.
"For 95% of people it won’t make a difference," he says. "But for wealthy people who think they are going to bang up against the lifetime allowance they will have to make changes. The difference is the maths, they need to plan around the 1.8 figure."
He adds that people in a defined contribution scheme that is heavily invested in the stockmarket should be mindful though.
"The stockmarket is down but if you expect a recovery, and history tells us a recovery normally follows a steep decline, you might find yourself with more than a million pounds in it and then if you continue to contribute into it and you’re some way off retirement, then you will be catching up to a stationary target of £1.8 million."
Mody says pension savers should consider their investment profile, the size of their pensions, and how much they’re contributing, to check they will not be caught out by the allowance.
Invented by a Frenchman in 1954 and ironically introduced in the UK on 1 April 1973, VAT is an indirect tax levied on the value added in the production of goods and services, from primary production to final consumption and is paid by the buyer. Its levying is complex, with a number of exemptions and exclusions. For example, in the UK, VAT is payable on chocolate-covered biscuits, but not on chocolate-covered cakes and the non-VAT status of McVitie’s Jaffa Cakes was challenged in a UK court case to determine whether Jaffa Cake was a cake or a biscuit. The judge ruled that the Jaffa Cake is a cake, McVitie’s won the case and VAT is not paid on Jaffa Cakes in the UK.
This is more usually a feature of car insurance but it can also crop up in contents, mobile phone and pet insurance policies. An excess is the amount of money you have to pay before the insurance company starts paying out. The excess makes up the first part of a claim, so if your excess is £100 and your claim is for £500, you would pay the first £100 and the insurer the remaining £400. Many online insures let you set your own excess, but the lower the excess, the more expensive the premium will be.