The further trimming of the LTA to £1m will leave a suprising number of people at risk of an unwanted tax bill, writes Jeff Salway
PROPOSED new cuts in tax allowances on pensions will catch public sector workers in Scotland off-guard and leave many facing huge tax bills, experts say.
They warn that long-serving public sector employees including doctors, nurses, teachers and police will bear the brunt of the government’s latest reduction in the amount that can be saved tax-free into a pension.
It announced in the Budget that the lifetime allowance (LTA) is being trimmed by another 20 per cent in April 2016, taking it to £1 million. The allowance is currently £1.25m, having been cut from £1.5m last year in a move that affected around 30,000 people, according to HMRC.
Pension savings in breach of the allowance are charged tax at 55 per cent.
While the new £1m allowance still appears too high to affect all but the highest earners, many public sector workers in defined benefit (DB, or final salary) schemes, including senior teachers and nurses, may be shocked to find that their benefits could eventually go over the limit.
Steven Cameron, regulatory strategy director at Aegon, said: “A £1m pension pot may seem huge, but with improvements in health and life expectancy, people who retire at 60 may need to use their pension income to cover their costs for 30 years or more. If you want your pension to continue to your partner and rise with inflation, £1m will buy you less than £30,000 a year. Many people aspire to more than that.”
The latest change came with a pledge to resume increasing the limit in line with inflation from 2018. But with further reductions possible before that point a growing number of middle-earners could be forced to review their pension plans.
Graham Vidler, of the National Association of Pension Funds, said: “Let’s hope past performance is not an indication of future cuts. The LTA has been cut by £0.5m in the last three Budgets which if repeated would leave an LTA of £0.5m. This would buy an income of around £10,000 a year.” David Smith, financial planning director at Tilney Bestinvest, said the new cap would have a “direct impact on many of the UK’s hardest workers”.
He gave the example of someone taking their 25 per cent tax-free cash from a £1m pension fund. The remaining fund of £750,000 would buy a retirement income of £18,632 a year, according to Smith, potentially falling below £15,000 after tax.
“This represents the size of annuity that a 65-year-old male could generate if he wished to ensure his wife would receive 100 per cent of his pension income should he predecease her, and also protect against the impact of inflation – eminently sensible decisions to make.”
Someone investing £10,000 a year in a pension currently worth £250,000 will breach the LTA by the time they’re 67 (assuming earnings growth of 3 per cent, investment growth of 6 per cent and 2 per cent inflation), said Gregor Munro, financial planner at Johnston Carmichael Wealth.
“Public sector workers –doctors, teachers, civil servants – who might not envisage this being an issue are likely to be impacted as anyone likely to receive a final salary pension in excess of £50,000 a year at retirement could be affected.”
Pension scheme members already close to or above the £1m LTA will be given the chance to apply to HMRC for protection, as they can with the existing limit, but new details have not yet been published.
Existing protection arrangements often involve making no further payments into your pension, although some forms of protection allow for future contributions.
“Many pension savers have benefited from applying for protection to preserve ‘lifetime allowances’ above the £1m proposed limit, although there is often a trade-off for securing these allowances of not making future pension contributions as this would result in some protections being lost,” said Smith.
The proposed changes mean some workers will need to review their whole retirement saving plans, including any workplace and private pensions built up. That may involve reducing or ceasing pension contributions, “de-risking” them to ensure that investment growth doesn’t take the pot above the new LTA or saving instead through non-pension arrangements, such as Isas.
Some will also be tempted to access their pensions sooner, under new rules taking effect next month giving people greater freedom with pension pots from age 55.
Jackie Holmes, a senior consultant at Towers Watson, said: “Someone with pension savings at the level of the LTA should therefore be better off taking their 25 per cent tax-free lump sum and putting the rest into drawdown; if they leave it untouched, investment growth could take them over the limit.”