12th December 2016
On 6 April 2016, the Lifetime Allowance for pensions was reduced from £1.25million to £1million. This may still sound like a large sum to most people but it is actually not difficult to exceed this amount. The Lifetime Allowance caps the amount you can accumulate within a pension fund without triggering an extra tax charge. Any pension funds above this amount will be subject to a Lifetime Allowance Charge. This is not the first time the LTA has been reduced. In April 2012 we saw it drop from £1.8million to £1.5million, followed by a further reduction in 2014 to £1.25million before being reduced again to the current £1million level.
Personal pensions, SIPPs and many group schemes are set up on a money purchase basis, which means that the value of your pension is tested against the allowance when accumulating benefits and it is then a case of calculating whether your pension fund is likely to be valued in excess of £1million by the time you draw benefits. There are a number of factors to take into account such as investment growth, ongoing pension contributions and charges and when you are actually going to take the benefits.
As you can see, all of these are variable and therefore an ongoing regular assessment of your pensions is vital to ensure that these assumptions are still correct. If you have benefits within a final salary pension scheme things get a little more complicated. These types of pension benefits are valued by multiplying your pension entitlement by a factor of 20. If you are entitled to a lump sum in addition to the pension, add this too.
Although less common, you may also be in receipt of pension payments (either from a final salary scheme or via an annuity) which started before 6 April 2006. If you have not taken any other pension benefits since, this pension income will also need to be tested against LTA, this time using a factor of 25.
The good news, however, is that two new forms of transitional protection - called Fixed Protection 2016 and Individual Protection 2016 - have been introduced if you happen to be affected by this most recent reduction.
Lifetime allowance planning is a complex area. If you think you may be affected, seek advice as soon as possible. There is no blanket solution for those who are affected by the change, as it very much depends upon your personal circumstances.
Richard was a member of a final salary pension scheme which he left several years ago when his employer closed the scheme. His entitlement from this scheme is a pension of £35,500 per year, plus a tax free cash sum of £265,000. Richard's employer has been paying into a personal pension for him, after the closure of the final salary scheme and this is currently valued at £200,000. His benefits for Lifetime Allowance purposes are valued as follows:
£35,500pa pension x 20 = £710,000
£710,000 + £265,000 tax free cash = £975,000
£975,000 + £200,000 value of his personal pension = £1,175,000
As Richard's total pension benefit value is in excess of £1million, he will be affected by the reduction in the LTA if he takes his benefits now and subject to a tax charge of 25% or 55% on the excess over £1million, with the exact amount dependent on how his excess pension benefits are paid. If he defers taking his benefits for a further period of time then additional contributions and future investment growth are likely to make the situation worse.