COLUMN: Introducing the latest backdoor raid on pensions

The lowering of the 'lifetime allowance' could affect many savers, Phil Cain explains how to avoid sleepwalking into a pension pothole.

by Phil Cain
Last Updated: 04 Oct 2013

As this year’s party conference season has shown, taxes on the "wealthy" make great political box office.

Both Labour and the Lib Dems want to introduce a 1% annual tax on homes worth over £2m. Delegates at both parties’ conferences gave the idea a riotous reception.

If a yacht tax had been promised too, they probably would have brought the house down.

The reason such taxes are popular is that they are clearly progressive, easy to understand – and usually only affect other people.

However there is another tax grab that has passed almost unnoticed, despite the likelihood that it will impact a surprisingly large number of people.

The ‘lifetime allowance’ is the amount of money you can save into a pension during your lifetime before you are hit by an eyewatering 55% tax charge.

Next April, it will be lowered from £1.5m to £1.25m.  That may sound a lot of money – but such pension pots are not the sole preserve of the very wealthy. Many more modest earners who save hard for their retirement could unwittingly fall foul of the reduced allowance.

Treasury 1, pension savers 0

Of course that is the government’s idea – it has been steadily reducing the lifetime allowance in order to drag more of us into the net, and increase the tax take for the Exchequer.

Next April’s cut will complete a 40% real terms reduction of the allowance in just four years. The compound effect of many years’ growth means that many people with a decent, if not diamond-encrusted, pension pot now will be hit by the tax charge.

Here’s an example – a 40-year-old company director decides he will retire at 70. Assuming his pension pot grows by 7% a year, it will nearly double in size every decade. So a relatively modest £188,000 in his pension pot now will surge past the £1.25m allowance before he retires in 30 years’ time.

Any money in his pot over the lifetime allowance will be taxed at 55% whenever he starts to take the benefits. The upper limit also applies to people saving into Defined Benefit (final salary) pension schemes; so senior civil servants, police officers, teachers or NHS staff could also be hit.

The formula used to calculate how much these pensions are worth – and whether they are subject to the tax – is different. But the principle remains – the lifetime allowance is no longer a problem reserved for the mega-rich, and the risk of falling foul of it increases as you approach retirement.

That’s the bad news, what’s the good news?

Well, there isn’t any as such. There is no single way to get round the shrinking lifetime allowance, but there are several things you can do to mitigate its effects. Here are a few suggestions for how to plan your way around it:

  • You can apply to HMRC for ‘Fixed Protection’ of your pension pot. This will lock in the current lifetime allowance of £1.5m, but you won’t be able to make any more contributions. This option is most likely to suit people already approaching retirement.
  • An 'Individual Protection' option is also being introduced from April 2014 for people whose pension savings already exceed £1.25m. It will allow members of employer pension schemes to continue to contribute - and could suit employees who are some years from retirement.
  • Owner-managers of companies can ask their spouse to build up a second pension pot - providing they too work in the business. Depending on circumstances, as a couple they could double up their £1.25m pots, or at least add a sizeable second income for the family.

One final word of warning – don’t try this at home! Pension planning is a complicated business, and a mistake now could cost you dearly down the line. Always seek expert help before committing to anything that will affect your retirement.

Finally, remember pensions are highly political these days. In other words, you could plan for these rules and be undone by the tinkering of future governments. It's wise to keep abreast of any changes and, if you're unsure, speak to your independent financial adviser.

Phil Cain is Director of CDC Wealth Management


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