01 July 2021
Jonathan Watts-Lay, director, WEALTH at work, outlines how to identify them and their options
As announced in the Budget, the lifetime allowance (LTA) will remain at its current level of £1,073,100 until April 2026. It’s been predicted that an estimated 10,000 individuals with large pension pots will pay more than £22,000 extra in tax by 2024 (https://bit.ly/3zuHKVj).
Whilst having over £1,000,000 in pension savings may seem unrealistic to most, breaching the LTA could be closer than many employees think. With the LTA frozen, we will see more individuals reach the threshold over time. It’s not just high-earners and those with defined benefit (DB) schemes who will be affected, but those who have saved from an early age, and whose investments have performed well. The tax implications could lead to many being hit with unexpected and sometimes unnecessary tax bills.
The LTA will typically affect one of the following three categories of individuals. By highlighting this, it can help employers identify who may be at risk of breaching it, so that the appropriate measures can be considered.
Those blissfully unaware – Most probably think that they aren’t one of the lucky ones to have a pension pot valued at, or more than, the current LTA limit of £1,073,100, but it’s quite possible that the value of their pot is far higher than they realise. This could particularly affect those who never or rarely check the value of their pension.
Also, many employees in DB schemes are unaware that for LTA purposes their pension is valued at twenty times their annual pension; so, an annual pension of £30,000 has a value of £600,000. Any tax-free cash received from the pension will also need to be added to this figure and tested against the member’s available LTA.
If a DB scheme member decides to transfer into a defined contribution scheme to take advantage of the pension freedoms, the transfer values offered can be much higher than the standard method of working out the LTA value. For example, transfer values can be as high as forty times the annual pension, and so, using the above example, an annual pension of £30,000 could have a transfer value of £1,200,000, exceeding the current LTA.
Those who think they are a long way off – This group believe that they are a long way from breaching the LTA, but in fact aren’t. This is particularly the case where employees are making healthy contributions into their scheme and perhaps receiving matching contributions. Positive pension fund growth as well as a pay rise may easily push them over the LTA before they know it.
If, for example, someone aged 45 with a pension fund of £400,000 and a salary of £50,000, saves 5% of salary into their pension which rises by 3% p.a. and receives employer contributions of 10%, it is possible for their pension fund to reach £1,381,000 by the time they retire at 65. (This assumes growth rate of 5% and excludes charges on the pension plans.)
Those who think they are protected but aren’t – Employees who have taken protection measures and opted out of their workplace pension scheme to safeguard their savings from a LTA charge, could still be at risk of a breach as re-enrolment occurs every three years.
Just one month’s contributions could invalidate protection previously granted, without employees realising. Responsible employers will inform employees whom they plan to re-enrol, so that they’re aware that pension contributions will be deducted from their monthly pay.
Many workplaces now offer support to their employees in terms of financial education, guidance and regulated financial advice. This approach helps employees understand all their options before making what could be life-changing decisions, therefore leading to better outcomes for all.
Steps that employees can take either to avoid or reduce the impact of the LTA
Review current situation – If they have already taken some pension benefits, they should look at a current pension valuation and assess how much of the LTA has been used. If employees have more than one pension, they will need to aggregate what has accumulated across all their pensions to identify the full amount.
Consider alternative savings vehicles – Individual savings accounts and workplace share schemes are two tax-efficient savings vehicles for employees to consider as alternatives, or supplementary to, a pension.
Opt-out – Some employees may choose to opt-out of their workplace pension but they need to understand that a decision to opt-out should not be taken lightly and that it could well be in their best interests to remain active in their scheme despite a potential tax charge. If employees are considering opting-out, it’s best that regulated advice is received from a suitably qualified adviser.
Take early retirement – A simple way for employees to avoid exceeding the LTA, or incurring further charges, is to cease pension contributions and take early retirement.
Featured in the July/August 2021 issue of Professional in Payroll, Pensions and Reward. Correct at time of publication.