3rd December 2013
Hundreds of thousands of pension savers are at risk of being hit with a combined tax charge of almost £50bn as a result of actually having saved too much according to new research.
Insurer Standard Life is warning people to check the amounts they have invested in all of their pension funds, as collectively they could exceed the maximum amount permitted in a pension wrapper.
The amount you are allowed to save into a pension, the so-called lifetime allowance (LTA), before being hit with extra charges, will fall to £1.25m in April 2014 and the taxman predicts the new limit will impact 360,000 pension savers in the long-term, as well as 30,000 immediately at the time of the change. The lower limit is not only likely to impact those with long service in a company pension scheme and those who are higher earners but those who will become higher earners in the future.
The new LTA could mean many savers are could be sleepwalking into a potential £49.5bn tax bill.
Someone set to receive a final salary pension of around £60,000 is likely be caught by the new limit. Even if their expected final salary is less than this, if they have also saved into a private pension combining the two funds together could see them close to the limit.
Pension savers who exceed the LTA will expose up to £250,000 of their pension savings to a massive 55% tax charge – leading to an unexpected tax bill of up to £137,500. This makes monitoring potential investment returns increasingly important as their pension pot nears the limit.
Research by YouGov, on behalf of Standard Life, shows less than a fifth, at 19%, of people know what the LTA is and just 31% of people earning more than £50,000 – the salary earners most likely to be impacted by the change – are aware of it.
Someone 10 years from retirement with multiple pension pots worth around £700,000 could exceed their allowance if their pot grows at 7% a year – even if they stop paying into it now.
Alistair Hardie, head of consolidation at Standard Life, says: “The stark reality is the reduction in the lifetime allowance is going to impact more people than first realised.
“And it looks as if these people are unaware of the risk of a tax charge they might be facing. Savers might be years away from retirement but if they have saved a fair amount in various pension funds they could be near the danger zone.”
What can you do?
The good news is people who are on track to exceed the limit have several options available to ensure they are not hit with an unnecessary tax charge.
There are two new protection options for 2014, allowing pension savers to lock into the current higher LTA of £1.5 million beyond 5 April 2014. These are ‘Fixed Protection 2014’ and ‘Individual Protection’.
Fixed Protection: This allows pension savers who feel their pension pot is below the limit but could be affected in the coming years to keep a £1.5m LTA beyond 2014. By taking fixed protection the person will be unable to continue to contribute to a defined contribution pension scheme, where savings are linked to stockmarket returns and in almost all circumstances final salary schemes.
Individual Protection: This option is available only to people with pension savings worth more than £1.25m on 5 April 2014. Crucially, this protection comes without the trade-off needed for fixed protection and individuals can keep funding their pension after April 2014 if they want.
There is a third choice, which is to continue to fund your pension and take the tax charge. Having no protection might mean paying more tax but it could still give the best result depending on personal circumstances – particularly if it means continuing to build-up additional years of final salary benefits including employer contributions.
Hardie adds: “There is no one size fits all solution. Each person’s individual circumstances will require a different solution. It is important that people look at their pensions, see if they are impacted and seek professional financial advice. And the sooner they act the better. The countdown to the new LTA has now begun and it could take several weeks or months before people manage to get all their pension fund totals from their different providers. If people leave it too late then their options might be restricted.
“Those with more than one pension pot may find it easier to assess if they are nearing the LTA limit in the future if they were to merge their different pensions together however that may not be the right solution for everyone.”