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Are you putting too much into your pension and risk being (tax) penalised?

Are you putting too much into your pension and risk being (tax) penalised?

There is a limit to how much you can save into your pension tax-free over your lifetime, known as the lifetime allowance (LTA). It’s been controversial because the government has steadily reduced the limit down from £1.8m in 2012. From this April 2019, the limit will be £1.055m.

Broadly speaking, it means there will be a tax charge on the amount in your pension over the allowance. The tax paid on this excess amount depends on how it is withdrawn (i.e. as a lump sum or in instalments) and it is charged at either the point you draw benefits, or if you have not taken benefits by age 75, a lifetime allowance test will be carried out at this age.

And although £1.055m may sound like a lot of money, more and more individuals are being caught by the limit, so, it is worth checking what your savings are forecast to reach - and if you need to take action to mitigate your potential tax liability. If so, there may be other, more tax efficient ways for you to continue saving for retirement.


What to do if you are nearing the lifetime allowance

1. Consider applying for protection

There are two types of protection that you can apply for which will fix your lifetime allowance at a higher amount:

Fixed protection 2016 – as long as you haven’t made a pension contribution since April 2016, this fixes your lifetime allowance at £1.25m

Individual protection 2016 – worthwhile only if your pension was valued at more than £1.055m in April 2016. This fixes your lifetime allowance at either the value of your pension savings as at 5 April 2016, or £1.25m.

 2. Take your tax-free lump sum

Rules introduced in 2015 mean that from age 55, you can withdraw 25% of your pension tax-free which could be a way to reduce the size of your pension savings if you are nearing the LTA. For example, if you are 55 with a pension worth £1,000,000 and funds aren’t yet being drawn, it is very likely, that with investment returns, the LTA will be reached. If you withdraw £250,000 from this pot and invest it elsewhere, then any growth on this element would not be subject to the LTA charge at 75. The only thing to remember is that there could be an inheritance tax implication on your £250,000 investment

3. Draw an income from your pension

In some circumstances, it may be possible to tactically draw an income from your pension to keep your pension fund below the LTA. However, there are lots of considerations around this, including rules such as the ‘money purchase annual allowance’. Triggering this means you and your employer can only contribute £4,000 a year to a money purchase pension. This is complicated so seek advice from a wealth adviser.

There are also options if you don’t need the income. For example, you could gift it or use it to fund a whole of life policy that pays out a lump sum outside your estate on your death, which could be used towards mitigating your inheritance tax liability.

Pensions are complicated – seek professional advice

Whether you are contributing to or drawing down from your pension, we would always recommend you seek advice from a professional financial adviser. In this article, we have deliberately simplified our explanations to show how an individual’s income levels can affect their pension allowances and contributions, but in reality the calculations will require significantly more work and explanation to ensure you make best use of the allowances available.


Our article also featured in Money Observer

Did you find this interesting? See more on retirement:

The tax treatments set out in this article are based on our current understanding of UK legislation. It is a broad summary and cannot cover every circumstance and it does not constitute advice. Levels and basis of taxation may change in the future. Investors should discuss their financial arrangements with their own tax adviser before investing.

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Nero Patel

Financial Planner

With over 16 years' industry experience, Nero provides strategic financial planning services to a range of private clients at Canaccord Genuity Wealth Management, in addition to professional introducers both personally and to their clients. Nero is highly qualified as a Chartered Financial Planner, a Certified Financial Planner licensee and a Fellow of the PFS. He is also qualified to give advice to vulnerable clients.

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IMPORTANT: Investment involves risk. The value of investments and the income from them can go down as well as up and you may not get back the amount originally invested. Past performance is not a reliable indicator of future performance.

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