Pensions poser as freeze is on for top allowances

Published on Friday 28 November 2008 19:37

LOOK beyond the headlines from this week's Pre-Budget Report (PBR) and there's plenty for pension investors to chew on. Most notable is the decision to freeze the Lifetime Allowance (LTA) at £1.8 million for five years from 2010, a move that could result in thousands of wealthy and low-income pensioners paying extra tax.

The LTA, currently 1.65m, is the maximum amount that can be invested in a pension over a lifetime before additional tax charges are levied on retirement.

Funds over the LTA and taken as a lump sum are liable to a charge of 55 per cent, while there is also a charge of 25 per cent on pension funds over the allowance and used to provide a pension income. The annual allowance – the maximum tax-efficient pension contribution a year – will also be frozen.

Currently at 235,000, the limit will rise to 255,000 by 2010 then remain at that level for five years.

At first glance, these changes only affect wealthy investors, but in reality many people with small pension pots could lose out from the freezing of the allowance. "It may look as though it only impacts on the highest earners, but it is something that middle-income earners will have to take into account now in planning their future pension provision," said Karen Goldschmidt, of the Association of Consulting Actuaries. "If you are considering saving for the long-term future, you surely have to assume the worst, that the LTA will not be raised again, and this will put you off making pensions savings now."

Even if you have paid no contributions since the Lifetime Allowance was introduced in 2006, you may be in danger of breaching it. For example, if your current pension fund is 1.2m, a 6 per cent a year return on pension fund investments would take you to the allowance threshold by 2016, if it remains frozen.

"Those that were continuing to contribute on the assumption that the LTA was increasing at a certain rate might now find themselves shortly in a position where they may be over the LTA – although they may have suffered a drop in value in recent months that will have reversed this," pointed out Graeme Forbes, chartered financial planner at Intelligent Capital in Glasgow.

The freezing of the limit introduces a damaging uncertainty into pension planning, believes Tom McPhail, head of pensions research at Hargreaves Lansdown. "If you're 50 years old now you don't know if your pension fund will breach the limit when you retire because you don't have a guide to what the limit will be. It discourages long-term pension investment so the government should at least set out its long-term intentions for the LTA."

If you think you could have a pension fund in the proximity of 1.8m by retirement, take a close look at how much you have got in your fund, factor in any investment projections and work out whether it is realistically in danger of going over the limit.

If you are in danger of exceeding the limit even without further contributions (due to future investment growth) it could be worth taking some benefits early if there is no penalty for doing so.

Those with smaller savings may also be affected by the freezing of the LTA. Under the trivial commutation rules, small pension funds can be taken as a lump sum, provided they are no more than 1 per cent of the standard lifetime allowance. Consequently, for each year the allowance is frozen 1.8m, more low income earners with pension pots of 18,000 or over will breach the 1 per cent limit. "If your pensions in total are under that threshold you can take them as cash," explained Iain Naismith, head of pensions market development at Scottish Widows. "If you go over you will have to buy an annuity. You could probably get one by the open market option, but the rate might not be good."

Someone with a pension worth around 18,500 could buy an annuity of around 400 or 500 per year, added Naismith, which translates into an income of just 40 a month.

As with high earners, the uncertainty over the future of the limit is damaging, said McPhail. "If you're a 50-year-old on 14,000 a year, what do you do? With pension credit rising by more than inflation and personal accounts in play from 2012 the means testing trap just got wider, so do you keep saving?"