How will the reduction in pension lifetime allowance affect me?
As the Government has recently launched the online application process for Individual and Fixed Protection 2016 (IP2016 & FP2016), we felt a reminder about the changes to the lifetime allowance (LTA) would be helpful.
In April 2016, the pension lifetime allowance (LTA) was reduced to £1 million, sparking concern amongst diligent savers. While £1m sounds like a generous sum, it is surprisingly easy to breach this limit, meaning you could be subjected to a tax bill of up to 55% on some of your pension pot.
If you think your pension fund could exceed £1m, you need to take action. With careful retirement planning and professional advice, you can protect your pension from these hefty charges.
What is the lifetime allowance?
The pension lifetime allowance limits the amount you can save into your pension schemes before an extra tax charge is applied. The limit is now £1m and includes the value of all pension benefit schemes, apart from the state pension. Any pension funds above this limit will be subject to an LTA charge.
Will the lifetime allowance charge affect me?
If you have a retirement savings plan and have been regularly saving into a pension fund, it is worth checking whether you could be affected by the new legislation.
For money purchase pensions, you simply need to calculate whether your pension fund will reach or exceed £1m by the time you plan to draw benefits, taking into account likely growth and future contributions.
What if I am in a final salary scheme?
With final salary schemes, that you haven’t started to receive an income from, you should multiply your pension entitlement by twenty, and then add any lump sum entitlements. While this may sound relatively simple, in practice it is more complicated.
For example, Henry was a member of a final salary scheme, entitling him to £52,000/year, plus a tax-free lump sum of £280,000. Henry also has a personal pension plan valued at £150,000. He should calculate the value of his total pension fund as follows:
£52,000 x 20 = £1,040,000
= £1,470,000 total pension fund
The lifetime allowance charge will only apply to any funds above the £1m limit and is deducted before the benefits can be paid out. If he takes a lump sum, Henry will be taxed at 55%, or for a pension income, the charge will be 25%, then the income provided will be subject to income tax in the usual way.
The value of pension benefits are usually only checked against the lifetime allowance when withdrawals are made, an individual reaches age 75, or death benefits from the scheme are paid out.
How can I protect my pension?
The key to protecting your pension fund is to keep a close eye on how much you’re putting in, relative to the lifetime allowance limit. It’s also important to review and monitor your investment performance. Choosing the right time to start withdrawing funds is vital and, with final salary schemes, it may be worth considering early retirement or accessing your pensions sooner than planned.
Depending on your situation, from July 2016, you might be able to apply for lifetime allowance protection that lets you maintain the previous £1.25m limit. Conditions are attached to these schemes and independent advice will help you make the best choice for your circumstances.
If you already have a protected lifetime allowance, you may not be able to apply for Fixed or Individual protection 2016 (or indeed need to). Independent advice should be sought if you are unclear about your protected lifetime allowance.
Finally, something else to consider…
Death-in-service benefit from an employer counts towards the Lifetime Allowance.
As death-in-service schemes are governed by rules of registered pension schemes, any lump sum payout will use up some of the deceased’s Lifetime Allowance, leaving the remaining balance available for their entire pension savings. However, this does not include a spouses scheme pension from the deceased’s occupational scheme.
As death-in-service schemes are governed by rules of registered pension schemes, any pay-out will use up some of the deceased’s Lifetime Allowance, leaving the remaining balance available for their entire pension savings.
There are now alternative employer-sponsored schemes available which do not count towards the Lifetime allowance, which can be considered.
For high earners or those for whom the Lifetime Allowance is a consideration, it is vitally important to be aware of any death-in-service you are entitled to.
This article is distributed for information purposes and should not be considered investment advice or an offer of any security for sale. This article contains the opinions of the author but not necessarily Ermin Fosse and does not represent a recommendation of any particular security, strategy or investment product. The information contained herein has been obtained from sources believed to be reliable but is not guaranteed. It is not a promotion of Ermin Fosse’s services.
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