Archived article: This article was correct at the time of publishing. Tax, investments and pension rules can change over time so the information below may not be current.

Financial Planning news

High earners should consider topping up their pensions before Budget Day

In the last Budget, the Chancellor announced a further reduction in the pensions lifetime allowance, which will come into effect from 6 April 2016. The lifetime allowance (LTA) is the value an individual can accumulate in their pension pots before a 55% tax charge applies when taking benefits. The reduction will see the LTA reduce to £1 million from the current £1.25 million and will ultimately result in the LTA being reduced by 40% since its peak level of £1.8 million during 2011.

A £1 million pension pot may seem a distant prospect. However, our figures show that even without investing a further penny, many savers in the middle of their working lives could, in fact, be on track to breach the LTA without realising it.

Based on the lifetime allowance increasing annually by 2% from April 2018 (the Chancellor has announced that the LTA will be inflation-adjusted from this date, so we have used the Bank of England's target rate), and an annual investment return net of costs attained of 5%*, the following pension pots for investors of different ages could breach the LTA. These figures assume that no further contributions are made:

Table 1:

 

Current pension assets held which might breach adjusted lifetime allowance

Current age

By age 55

By age 60

By age 65

30

£480,000

£415,000

£360,000

35

£555,000

£480,000

£415,000

40

£641,000

£555,000

£480,000

45

£741,000

£641,000

£555,000

50

£857,000

£741,000

£641,000

55

N/A

£857,000

£741,000

e.g. A 30 year old could breach the lifetime allowance if they currently have £480,000 in their pension pot by the time they are age 55.

Assuming the above, and that a monthly pension contribution of £250 is made, the following levels of assets could potentially breach the LTA:

Table 2:

 

Current pension assets held which might breach adjusted lifetime allowance

Current age

By age 55

By age 60

By age 65

30

£436,000

£367,000

£308,000

35

£517,000

£436,000

£367,000

40

£610,000

£517,000

£436,000

45

£718,500

£610,000

£517,000

50

£845,000

£718,500

£610,000

55

N/A

£845,000

£718,500

 

Tax relief on pension contributions is rationed on the way in and will soon be cut back even further for high earners. When you take pension benefits in retirement, with the exception of a tax-free lump sum of up to 25%, your income is subject to tax at your marginal rate. Given this, the whole concept of a lifetime allowance is highly punitive and ultimately penalises decent investment performance. It is a deterrent to making provisions in retirement and adds complexity.

We would like to see the lifetime allowance scrapped. Until it is, however, those with large pension pots that are likely to breach it should consider fixed protection to retain the existing £1.25 million allowance and think about funding a combination of ISAs and taxable growth investments. They can also use their capital gains allowances and potentially riskier Enterprise Investment Schemes and Venture Capital Trusts.

Savers need to keep a close eye on the performance of their pensions, however. This is because there is always the ability to break the protection and restart funding if the plan falls behind or if the LTA is scrapped or uprated at some point.

If you would like to discuss the above, or your investments, please give us a call on 020 7189 2400, request a call back or email us at best@bestinvest.co.uk

*Figure is compound. Returns are not guaranteed.

IMPORTANT INFORMATION

The value of your investments can go down as well as up, and you can get back less that you originally invested. This article does not constitute personal advice. If you are in doubt as to the suitability of an investment please contact one of our advisers.

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