Chancellor Jeremy Hunt today retained the state pension triple lock in his Autumn Statement today in a boost to retirees. But there was no mention of the lifetime allowance – the amount that savers can accrue in total pension benefits before having to pay a tax penalty.
The standard lifetime allowance is already frozen at £1,073,100 until 2025/26, having been reduced from a peak of £1.8million in 2012. The freeze was widely expected to be extended until 2028 in line with other allowances and thresholds but clarification might have to wait until the full Spring Budget.
Gary Smith, Financial Planning director at wealth manager Evelyn Partners, says: ‘The current freeze is leading to more additional tax charges on excess amounts above the threshold when savers come to take their pension benefits or turn 75. The rate of tax paid on pension savings above the LTA is 55% if it is taken as a lump sum, and 25% if it is taken in any other way, for example draw down or cash withdrawals.’
State pension triple lock
Hunt and Sunak have retained the state pension triple lock for the moment, which on balance is not so surprising as although extremely expensive for the Treasury the device was a manifesto commitment. This means the state pension is set to rise by 10.1% from next April, at a cost of about £10billion to the Exchequer – which illustrates the steep budgetary cost of maintaining this pledge. The full state pension for those retiring after April 2016 will rise to £203.85 per week or £10,600 per year – taking it above the £10,000 benchmark for the first time.
Smith says: ‘Even wealthier savers should not underestimate the value of the state pension, and therefore the importance of it keeping pace with inflation – for all demographics, including younger workers, as they will one day hopefully benefit from the current maintenance of state pension levels.
‘Our calculations show that a 66-year-old in good health would require at the very least a sum of £229,233 in their pension to purchase an annuity with a starting annual income of £9,627.80 (the current state pension), which will increase in line with inflation, paid monthly in arrears with a five-year guarantee.’
Lifetime allowance
Smith says: ‘While the absolute numbers being penalised under the LTA seem quite small, this conceals much greater numbers of savers who have restricted or halted their pension contributions in order to stay the right side of the LTA.
‘That is not just members of generous defined benefit schemes like teachers, doctors and civil servants, but also – and this will only snowball in the coming decades – workers who have saved from an early stage in their careers into a defined contribution scheme.
‘People retiring at 55, 60 or even 65, have several decades of retirement to fund and often a mortgage to pay off. In a higher-inflation environment, ever greater levels of pension saving will be required for a comfortable retirement, and striving for this could see many more savers clashing with the LTA.’
What does it mean for savers when their pension is approaching the LTA?
Smith says: ‘It is far from an open-and-shut case that all savers should avoid crossing the LTA: each individual must examine their circumstances, as the following worked examples show, but it is a potentially complex area that can benefit from financial advice.’
A basic rate taxpayer, who is a member of their employer pension scheme, should still consider maintaining contributions even if the value of their pension funds exceed the lifetime allowance of £1,073,100. If the employee is contributing £1,000 (gross), and the employer is matching this payment, then £2,000 (gross) will be paid each month into the pot. As the basic rate taxpayer would receive 20% tax relief on their own contribution, they would only actually contribute £800 (net) to ensure that £2,000 is contributed each month.
When the individual comes to retire, they would suffer a lifetime allowance tax charge on any benefits drawn above their available allowance. If they took the excess as £2,000 (gross) per month, a lifetime allowance tax charge of 25% (£500) would be deducted by the pension scheme and, if they were a basic rate taxpayer, they would pay a further 20% (£300) on the reduced monthly income of £1,500. The overall tax charge would be £800, which is 40% of £2,000 (gross), and the net income of £1,200 is £400 higher than the net £800 they had been contributing each month. This represents a 150% uplift on the net employee contribution.
If the employee was a higher rate tax payer, they would only need to contribute £600 to have the £2,000 (gross) per month added to their pension. However, when they took their retirement benefits, the lifetime allowance tax charge of 25% (£500) would still be applied on £2,00 (gross) income, with 40% (£600) income tax deducted from the £1,500 monthly income (net of lifetime allowance tax charge), resulting in a net income payment of £900. Again, this represents a 150% uplift on the £600 (net) contribution.
