In his Budget in March, the Chancellor announced that the pension lifetime allowance would be frozen at its current level – which is £1,073,100 – until April 2026.
This cap on the amount you can pay into your pension pot before it becomes liable for taxation when you take it out means that a growing number of people could face a hefty tax bill when they retire.
The current rules state that tax is payable at 55% on everything over the £1,073,100 limit if you take the money as a lump sum, or 25% if you take the money in another way, such as an annuity, or drawdown.
Here, Tony Clark, Senior Propositions Manager at St. James's Place Wealth Management, answers some common questions about what this might mean for you and your pension.
Certainly, it will affect the wealthiest investors the most, but there will also be a kind of ‘drag’ effect that could create issues further down the line for many ‘middle-earners’, who may not necessarily see it as a problem at the moment. That’s because, if and when the lifetime allowance does begin to increase again in five years’ time, it will be starting from a lower base, the result being that more people will be likely to reach the limit in the future. So a lot of investors might not see it today, or even in the next few years, but it may become an issue for them later on.
What’s more, because the concept of retirement continues to change, a lot of people will carry on working well into their mid-60s and beyond. That means they could continue paying into a pension for a longer time, giving them a longer period for potential growth and a much higher probability of reaching that lifetime allowance.
No, not at all – the allowance covers both defined contribution and defined benefits pensions. A lot of commentators are focusing on the defined-contribution side because the maths is simpler. Meanwhile, for defined-benefit pensions, it’s much more complicated to understand the potential tax situation and how it’s calculated.
What’s more, there are a lot of people, usually in their 40s and early 50s, who might have a mix of both – and the rules apply across the two, which means you can end up with a mathematical nightmare. A lot of people in that situation will be asking: “Where do I even start with trying to figure it out?” And the best option, of course, is to seek expert financial advice from someone who can explain how it will pan out for you.
When the Chancellor announced the freeze, there was a lot of doom and gloom about it. For example, some were saying it will make pensions look less attractive. However, I take a different view. This shouldn’t put people off pensions: they are still far and away the most tax-efficient way of saving for your retirement, especially considering the tax relief available on your contributions, as well as the freedom of choice you now have in how you access your pension when the time comes.
So, instead of thinking of the lifetime allowance freeze as a barrier or a problem, you should see nearing that limit as a trigger to consider your additional options. At this point, it would be useful to have a discussion with your financial adviser, get properly informed as to the details of your own circumstances, and ask questions such as: “Do I need to worry about this? If so, do I need to adjust my course?”
As with all tax issues, it’s mainly about being aware of the situation, knowing what’s there and realising that you don’t necessarily have to solve the problem by yourself.
The most important thing is to start with the end in mind. Think about how you want your retirement to look, then you can consider the mechanics of how you might structure your income in retirement and how to save for it now. Many people these days are going to need a range of assets to draw from, of which their pension will be just one. But you can also take into consideration ISAs – which are also tax-efficient – property, other investments, state benefits and the fact that you might still be earning. There are all these different elements that you can line up, and when you get to retirement you can work out which levers to pull on to create your income.
So, for some, their pension is going to make up the vast majority of their retirement wealth. But for many others, retirement is going to be so less linear, particularly for people who are only in their 40s or 50s now, which means they may want to consider taking a more broad-brush approach. Therefore, it’s best to consider the pensions lifetime allowance as a reason to review your pension regularly with your adviser, rather than a reason not to have a pension at all.
To help you get the most out of your pension, and to consider your most suitable options for saving for retirement, get in touch.
The value of an investment with St. James's Place will be directly linked to the performance of the funds selected and may fall as well as rise. You may get back less than the amount invested.
The levels and bases of taxation, and reliefs from taxation, can change at any time and are generally dependent on individual circumstances.