Will you be caught out by the lifetime allowance?

Published by Michelle McGagh on 22 October 2015.
Last updated on 22 October 2015

LTA image

However, while this might seem like a lot of money, breaching the allowance and incurring a tax charge could be easier than you think, especially if you’re in a final salary scheme or have been saving for a long time.

In fact, it’s estimated that by the time the new rule kicks in, 460,000 individuals could be affected.

How do I find out if I’m in danger?

Calculating whether you are near the LTA differs depending on whether you are in a defined contribution or defined benefit (including final salary) pension.

For DC savers, it is much easier to see whether the total sum saved into your pension is at or near £1 million, and your pension provider will be able to give you an up-to-date valuation.

However, for those in DB schemes, the calculation is much more difficult because there is no ‘pot’ of money to check on. Instead, the pension scheme works out how much income you will receive each year based on a multiple of years worked and a percentage of final salary, then it multiplies this figure by 20.

This means a retiree would be entitled to a retirement income of £50,000 a year before they breach the threshold (£50,000 x 20 = £1 million).

What kind of person is likely to be caught out?

Andy James, head of retirement planning at financial advice firm Towry, says that previously it was only the “higher echelons” of public service officials and business executives paying into DB schemes that would have been caught out, but repeated reductions in the lifetime allowance mean “middle managers” are now breaching the threshold.

“It used to be the man running the hospital who would go over the lifetime allowance but now that it will be reduced to £1 million it is going to be people who do 40 years at the hospital and get two-thirds salary in retirement who are earning £70,000 a year,” he says.

“Doctors and surgeons will go over the £1 million and in the civil service you are looking at department managers who will find they have saved too much.”

Tax charges

Those who exceed the threshold face a tax charge – either when they start taking benefits or reach age 75. Just how you will be taxed will depend on whether you take the excess as a lump sum or income.

If you take the extra as a lump sum, you would pay the 55% charge upfront and the remainder would be paid directly to you. However, if you decided to take it as income, then 25% is charged upfront and the remainder is added to the rest of the fund, which is taxed under PAYE and at marginal income tax rates. 

The tax charge for both options is broadly the same. So, if your fund was £10,000 over the LTA, you would pay a charge of £5,500 for taking your money out as a lump sum, and receive £4,500 in your pocket. Going down the income route, you would pay 25% upfront – so £2,500 – and then assuming you pay tax at 40% – you would pay a further £3,000 on the remaining fund. Again, this would leave you with a tax bill of £5,500 with £4,500 in your pocket.

Carry on saving

Even if you’ve got close to £1m, it doesn’t mean you should stop saving, especially if you are used to a high income. James says: “£1 million seems a lot but stretched over 30 years of retirement it is not quite so much”.

“Isas would be the next port of call, so maximum fund your Isas up to the current limit of £15,240. Then I would say look at your investment portfolio, as you can take money out of it tax-free using the capital gains tax limit of £11,100.”

He adds: “The thing that people forget about if they are married or have a civil partner is that they can use both sets of allowance.”

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