Protecting your pension from the Lifetime Allowance Reduction

 

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From 6 April 2016, the lifetime allowance (LTA) for pensions will reduce from £1.25m to £1m and this could potentially affect a significant number of savers according to a recent article in the Financial Times. Figures suggest that if you earn £80,000 or more, or have saved funds of £600,000 or more into your pension, you should consider action to protect your self from the LTA danger zone. Any savings in excess of the LTA will incur a tax charge of up to 55% when LTA is triggered on the withdrawal of funds.

 

If you think that you may breach the £1m limit during your working lifetime, e.g., you are a high earner or have a defined benefit (final salary) pension, it is a good idea to check the value of your pension to date and request projections to see how your selected retirement age and investment growth will affect that value. If you have only money purchase pensions (as opposed to a defined benefit pension), it is simply a matter of determining whether your pension fund is likely to be valued in excess of £1m by the time you draw benefits (you also need to consider any pension benefits you have previously begun to draw). You will need to take into account the likely fund growth and future level of pension contributions, but an adviser can do that for you. However, if you have benefits within a defined benefit pension scheme (deferred entitlement or benefits still accruing) it can be more complicated because these types of pension benefits are calculated on a percentage of your salary at retirement. If you are entitled to a lump sum in addition to the pension, you will also need to add this.

 

The government does have arrangements in place to offer some protection to savers and it may be possible for you to apply to HM Revenue and Customs for either Fixed Protection or Individual Protection, both of which can both help to reduce or eliminate an LTA tax liability. However, these protections come with conditions and the best course of action for you will depend on various individual factors and should be considered very carefully.

 

The LTA is a complex area, and the right solution for you will depend on your personal circumstances. Seeking independent advice will ensure that you make the right decisions in good time. If you would like more information on the LTA reduction you can read more in the Gov.uk LTA policy paper or ask your financial adviser.

 

 

 

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Pension Withdrawals - Paying your Tax

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Since the new pension freedoms were announced in April 2015, if you are over 55 you have been able to withdraw money from your pension in a whole new way, you can now even withdraw the entire pension pot if you wish. However, before you make a decision on withdrawing money from your pension it is a good idea to familiarise yourself with the new tax implications so that you do not pay too much tax. The key point to understand is that money that you take from your pension pot may be added to your taxable income for the current period and will be taxed at your marginal rate. Therefore, if you don’t need to take a large cash lump sum from your pension, you could save yourself a big tax bill by choosing to go into flexible drawdown and take money from your pension pot over a number of years instead.

 

For example, if you have £30,000 income a year, your marginal rate of tax is currently 20%. If you cash in a pension pot worth £90,000, even after taking your tax-free lump sum (currently 25% which equates to £22,500), your total income for the year will be £97,500. This pushes you over the 40% tax threshold (£31,785 in the 2015-16 tax year after the personal allowance). Below the 40% tax threshold you will be taxed at 20% for everything above £10,600. £10,600 being the 2015-16 allowance that everyone can earn tax-free. This would mean that your tax payable would be £28,403 on your total earnings, or £16,403 on your pension pot for the tax year 2015-16 (if you have no other income).

 

Or, if you have £45,000 income a year, your marginal rate of tax is 40%. If you cash in a pension pot worth £300,000, even after taking your tax-free lump sum (currently 25% which equates to £75,000), your total income for the year will be £225,045. This pushes you over the 40% tax threshold and into the additional tax bracket (over £150,000 in the 2015-16 tax year). Below the 40% tax threshold you will be taxed at 20% for everything above £10,600. £10,600 being the 2015-16 allowance that everyone can earn tax-free. Above the 40% tax threshold you will be taxed at 40% for everything above £31,785 up to the additional rate tax threshold (currently £150,000 for the 2015-16 tax year). Anything above £150,000 will be taxed at 45%. This would mean that your tax payable would be £122,476 on your total earnings, or £83,153 on your pension pot for the tax year 2015-16 (if you have no other income).

 

Whether you wish to take a lump sum, go into pension drawdown or take out an annuity will be a decision based on your individual circumstances and needs. The key to reduce your tax liability is to understand the trigger events and work with the tools available to you so that you are not paying undue tax on your pension pot. Although the new pension freedoms look simple enough on the surface, it is always worth talking through your options with an independent financial adviser at the outset. Your adviser will be able to offer advice on all areas of retirement planning including: triviality and small pots; flexible drawdown; annuities; and tax liability on death, so that you can put a plan in place that efficiently takes you from where you are now, to where you need to be in the future in the most tax efficient way possible.


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