UK: Race to save pensions from tax raid
14 March 2014
Posted by: Author: Kyle Caldwell
Author: Kyle Caldwell
Thousands of savers will next month be subject to the latest government tax raid on pensions. From April 6 the maximum amount of pension wealth savers are allowed to accumulate during their lifetime will be reduced from £1.5m to £1.25m. Anyone who breaches this limit will face a tax charge of up to 55pc on the excess.
The cap is called the "lifetime allowance” and applies to an individual’s entire pension savings and entitlements outside of state provision, from company final salary schemes to self-invested personal pensions.
The reduction to the lifetime allowance is an unapologetic attempt by the Government to raise taxes at the expense of wealthier savers. Most of those in immediate danger have acted in advance – often with the help of financial advisers or pension providers – to protect their retirement funds.
However, hundreds of thousands of others are drifting towards this penalty for saving too much and will need to adjust the amounts flowing into their company or personal pensions.
Say, for instance, your pension pot grew to £1.5m. You could take the £250,000 excess as a lump sum less the 55pc tax charge – so £112,500. This is the route most will take.
The alternative is to take it all as income. Here, the pension provider strips out 25pc of the excess – so £62,500 – and hands it to HM Revenue & Customs.
Income, paid from the remainder, attracts income tax rate. HMRC expects most will be higher-rate taxpayers; the combination of 40pc income tax and the 25pc charge equals 55pc overall.
Those who took only enough income to be basic-rate taxpayers would pay nearer 40pc overall in tax, according to Standard Life, the pensions provider. However, this is a rare course of action for those with such large funds.
Who is affected?
Initially, around 30,000 people will be affected. Most will be higher-earners who maximised pension contributions throughout their careers, or who work in jobs which provide generous final salary-type pensions. The latter category includes doctors, head teachers and senior civil servants in the public sector.
HM Revenue & Customs estimates that the reduction will impact 360,000 pension savers by 2030, as more people build up larger funds.
This extends to savers whose pensions are nowhere near the limit today. Calculations by Standard Life show that someone 10 years from retirement who had amassed a £700,000 fund only needs to achieve a 7pc a year annual growth to breach the lifetime allowance. And that is before any more contributions are made.
Someone aged 40 with £220,000 in pensions savings would breach the limit by 65 at this growth without adding another penny to the pot.
How final salary schemes are implicated
It is clear savers with one or more pension funds totalling more than £1.25m are affected. It is less so for members of final salary schemes.
To calculate the value of final salary benefits, HMRC multiplies a pensioner’s annual income by 20. So someone who retires on £62,500 a year would be right on the cusp of the £1.25m annual allowance.
The most generous schemes pay 1/60 of a worker’s final pay packet for every year worked. So a 60 year-old earning £150,000 who had worked 30 years would be due £75,000 a year – equal to £1.5m, which breaches the lifetime limit.
The simplest way to avoid the tax hit
Those who have savings between £1.25m-£1.5m, or expect to go over the limit in the future, need to act fast to protect their money.
There are two ways pension savers can shield this £250,000.
One is through applying for "fixed protection 2014”. This effectively ensures that the lifetime allowance cap stays at £1.5m. The drawback is that you must immediately stop making contributions. This will suit savers who are near retirement most. The deadline to obtain this protection is April 5. Apply by contacting HMRC (call your tax office or visit hmrc.gov.uk/pensionschemes/fp14online.htm).
Other routes to consider
If you are in a generous final salary pension, you’ll need to figure out what your benefits will be worth when you retire. Each pay rise and each year of extra service will increase the income you are due.
It is also worth bearing in mind that this and future governments could further tax pension pots. Last week Labour leader Ed Miliband sparked another pensions-related furore by suggesting higher earners should enjoy less tax relief on pension contributions. Senior Liberal Democrats, meanwhile, have indicated they would like to cut the lifetime limit further.
Some workers, particularly doctors (see below), may take early retirement. Others will need to opt out of their final salary scheme at work. Savers could also consider switching pension investments into lower-growth assets such as cash, as soon as the £1.25m limit nears. This would limit growth and therefore avoid the tax.
In some cases, it could be worth accepting the 55pc tax charge and continue to pay in contributions. If your fund is greater than £1.25m already, you can opt for "individual protection 2014”. This keeps the cap on your fund size at £1.5m, but allows additional contributions.
Analysis by Master Adviser, a London-based advisory practice, showed a 50 year-old with £1.5m in a pension could grow their savings to £2.86m in 15 years’ time by maximising annual contributions. This assumes 6pc a year growth after charges and accounts for the 55pc tax charge.
Had the individual stopped contributing and put the money that would have been saved into a pension elsewhere, the pot would be worth £2.8m at age 65. This is a difference of £60,000 – which all comes from the tax relief afforded on pension contributions.
* GPs are especially likely to fall within the tightening pension tax net. But the questions many now face illustrate how complex savers’ situations can become.
* A GP’s pension "pot” is valued, for the purposes of calculating the tax due, at 20 times promised retirement income plus their lump sum. GPs receive a lump sum of three times their annual pension entitlement. So any GP whose pension income is £55,000 a year or more is going to cross over the new lifetime allowance limit of £1.25m.
* If they draw the pension early, it is reduced by a set ratio (the exact ratios vary depending on which part of the scheme they are in). For the "1995 section”, if they draw the pension at 55, they get only 78.7pc of accrued pension, at 56 it is 82.5pc, at 57 it is 86.5pc.
* So even though the pension is paid out for more years, the reduced "headline value” means it is seen as worth a lot less in lifetime allowance calculations.
* GPs who have already accumulated entitlement to, say, £65,000 of annual pension, could, by taking the money at 55 or 56, keep themselves under the lifetime allowance limit. Waiting to 60 might trigger a bill of over £130,000 in extra tax depending on how they structured their pensions.
Why work two years longer for an extra pension that is just going to be clobbered in tax?
The problem is clearly troubling long-serving GPs in their fifties. One leading independent financial adviser said: "In the past month alone we’ve advised three GP clients to plan to draw their pension between ages 55 and 57, and cut down to limited working hours, because otherwise they will face massive additional tax bills. If we are just one firm saying that, it is reasonable to assume that across the country, hundreds of GPs will be advised to draw the pension early and work much reduced hours.”
This article first appeared on telegraph.co.uk.