Lifetime Allowance: How not to fall foul of the complex annual allowance

In March this year, reported that there was a 40% increase in the number of people who fell foul of the pension Lifetime Allowance in the 2016/17 tax year, after it was cut in April 2016.

Lloyd Davies, Chartered Financial Planner at Central Investment, breaks down the most recent lifetime allowance changes on pension contributions and how to deal with the complexities, in order to make your pension last a lifetime.

The lifetime allowance is the maximum amount you can save into a pension over your lifetime while still qualifying for valuable tax breaks. The tax charge for exceeding this is different depending on how the income is taken: 55% if taken as a lump cash sum or 25% if it is taken as income.

Figures gathered by Old Mutual Wealth in 2018, revealed that 2,410 people went over their lifetime allowance. This resulted in the government collecting £110m in 2016/17, an increase from 2015/16 figures which saw 1,610 individuals caught by the rules, paying £80m in tax.

Over the last decade the allowance has moved between £1.8m to £1m; and for the first time since April 2010, the government has increased the lifetime allowance on pension contributions by £30,000, from £1m to £1.03m, in April 2018.

Although this increase isn’t huge, it will provide some relief to those currently on the threshold of exceeding the allowance and will see a saving of up to £16,500 for those with large funds.

Reaching the Limit

From the outset, a lifetime allowance of at least £1m seems reasonable. However an increasing number of taxpayers, who have been responsible and saved for retirement, are being caught by this super tax trap.

For example, the capital value of deferred pensions in final salary schemes and the high cash equivalent values currently being offered to members has resulted in people unexpectedly breaching or getting very close to the limit. This is often due to there being a lack of realisation of the true value of these arrangements.

If we were to look at a 35-year old earning £57,000 a year with total pension contributions - including employer contributions - equalling 15% of their salary, they would end up exceeding their lifetime allowance by the time they are 70.

It’s also crucial that individuals do not assume that the lifetime allowance is only a concern for the top 1% earners, as the allowance would need to increase to over £4.5m if it were to only affect the top percent of the population.

Planning Ahead

As the government continues to restrict tax relief on pensions, more people than ever will find that it is not tax efficient to save any more into their pension, either in a given year or over a lifetime.

It is imperative for individuals to plan ahead to ensure they make the most out of pensions, without having to pay higher tax. But, the question is, will the government unexpectedly increase or decrease the lifetime allowance from its current figure?

If yes, how do you plan savings over a 40-50-year period when the government changes the rules so often?

Well, alternatives are available. The annual ISA allowance increased to £20,000 from April 2017 and there are also further niche tax-efficient schemes. Our advice – take full advantage of ISAs and make sure you are making full use of your capital gains tax allowance.
In March this year, reported that there was a 40% increase in the number of people who fell foul of the pension Lifetime Allowance in the 2016/17 tax year, after it was cut in April 2016. Read more to find out how to make your pension last a lifetime. 
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