Crucial changes for those with large pension pots
First published 09 April 2014 • Updated 08 August 2017
The new reduction to the lifetime allowance for pensions can have a big impact on those with larger pension pots. Carl Lamb looks at the implications.
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Ever since the radical pension upheaval in 2006 (known as A-Day), there has been a limit set on the maximum amount you can hold in pension savings without incurring tax penalties. The lifetime allowance for pensions (LTA) was set at £1.5 million at A-Day and had increased to £1.8 million by 2011. In a change of direction, the government has since reduced the LTA, returning to £1.5 million in 2012 and lowering it again from 6 April this year to £1.25 million.
“if you take anything over your lifetime allowance as a lump sum, the tax charge is a massive 55 per cent whereas if taken to purchase an income (such as an annuity) it drops to 25 per cent”
Don’t get hit by a hefty tax charge
What this means in practice is that if your total pension savings are above the LTA when tested – of which more below – you will be hit by a punitive tax charge. The level of the charge depends on how you are taking your pension benefits: if you take anything over your LTA as a lump sum, the tax charge is a massive 55 per cent whereas if taken to purchase an income (such as an annuity) it drops to 25 per cent. This charge is on top of any normal income tax due on the income you’ve purchased.
The LTA test will be applied even if you have made no contributions yourself to the fund or if you are a member of a “defined benefits” scheme – i.e. one such as in the public sector where your pension is based on your salary and length of service rather than on the contributions paid into it and any investment growth.
The value of your pension savings is tested and the LTA charge levied when you start to draw pension benefits from your fund or when you reach age 75, if you haven’t started drawing benefits by then. A test can also be triggered by other events, such as transferring your pension to a qualifying recognised overseas pension scheme or if funds are paid through ill-health or death benefits.
There will be those whose total pension savings already exceed the new threshold. A range of protection measures have come and gone for those with large pension pots over the years and hopefully those with pension savings over the old threshold of £1.5 million will already have entered into one of the available schemes. But with the new threshold of £1.25 million, new pension savers will now find themselves facing the LTA tax charge.
Individual Protection 2014
Individual Protection 2014 is the latest protection scheme to be offered – and the only one now available to pension savers without any earlier form of protection. It’s available to those with pension savings over £1.25 million and below £1.5 million at 5 April 2014. Under Individual Protection, you are given a personal LTA based on the value of your fund at 5 April 2014.
“Individual Protection isn’t available yet – it will be launched by the government in August 2014 – but you have until 5 April 2017 to register for it”
Although you can no longer make regular contributions to your fund after that date, you are permitted to make a final one-off contribution to bring your fund up to your individual LTA before you retire, if you so wish. This might be appropriate if your fund has reduced in value from the April 2014 valuation. With defined benefit schemes, you may continue to accrue benefits but the LTA tax charge will be payable on any excess over your individual LTA when you retire.
Individual Protection isn’t available yet – it will be launched by the government in August 2014 – but you have until 5 April 2017 to register for it. It is possible to have Individual Protection running in tandem with most of the earlier protection schemes – although “Primary Protection”, which dates back from 2006, can’t be used with Individual Protection.
Measure your potential liability
Working out the value of your fund is the first step in measuring your potential liability to the LTA tax charge. For those with defined contribution schemes, it is simply a matter of adding up the current total value of your pension savings. If this falls between £1.25 million and £1.5 million, then there is a very good chance that Individual Protection would work for you.
If you are a member of a defined benefits scheme (occupational pension), then it is a little more complex: in most cases you will need to multiply your expected annual pension income by 20. As a guide, if you are looking at a pension income of over £62,500 a year, then Individual Protection may be for you.
Large pension pots are, of course, rare but for those who are lucky enough to have funds at or above the new threshold, it is important to understand the LTA rules and to get advice about what protection is available for you.
About the author
Carl Lamb is the Founder and Managing Director of Almary Green Investments Ltd, Carl is passionate about delivering a quality service to clients.
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