Throws light allowance and why it doesn’t matter the significant publicity that surrounds the freezing of the lifetime allowance, with immediate effect, has led many individuals with pensions to consider whether pension savings remain the most appropriate means to make plans for their retirement in the future.
I still consider pensions to be uniquely tax privileged, and despite what for many wealthier individuals will unquestionably be a tax rise, I still think pension shall provide the cornerstone of retirement planning for most people.
Thinking only of lifetime allowance considerations (i.e. ignoring the annual pension limits) anybody that doesn’t have a previously protected lifetime allowance is likely to be best served by being an active member of a pension scheme. If that pension scheme is defined benefit pension, you will invariably have the enjoyment of a guaranteed income, sponsored by your current employer, at a far lower cost than what you would need to have in a fund if you were funding for personally, even with a commensurate employer contribution.
But this is not to say that defined contribution schemes are of no value, it’s just a simple reality that the increases in the likely lifetime allowance take, and the cost of providing for guaranteed income and the cost of providing for a lifetime income, in a world where people are living longer (and invariably with greater income needs) is simply higher than what used to be.
For those of benefits over £1.073 million there is the risk of a lifetime allowance charge stop in defined benefit pensions the lifetime allowance is sufficiently generous to allow a I thought because the phone rang.
Within a defined benefit regime the lifetime allowance especially generous to allow an income of in excess of £50,000 per annum, and potentially, or potentially, a tax-free lump sum stop this income, I think by coincidence, would fully make use of an individual’s personal allowance, and basic rate tax band, so particularly if there are serious state pension, the likes be higher rate taxpayer.
It is well publicised that a defined contribution pension of the same values the lifetime allowance is unlikely to give somebody a guaranteed income, which is inflation linked, with the spouse’s pension et cetera in the same way defined benefit pension would, but this is mainly due to the cost of guarantees.
However a defined contribution pension can give a 25% lump sum and communal cumulative income up to the lifetime allowance before any additional lifetime allowance tax charges are paid. One key differential between defined benefit one additional key differential between defined benefit and defined contribution is that a defined benefit pension will invariably only be tested once again slight amount, at the individuals normal retirement date, and never again even if they die and leave a dependent’s pension. However a defined contribution pension is tested when the punitive withdrawals broadly equal the lifetime allowance (commonly this is because they’ve taken 25% of the light allowance of the tax-free lump sum) but then again at age 75 to add back in the growth, or if they do not hit the light allowance before 75 through these punitive crystallisation is, if they die before that.
However, those a big test against lifetime allowance either at 75 of the cars they have hit the lifetime allowance before 75 will not normally see their pension benefits test against the light allowance for a second time. Put another way, crystallised pension benefits are not testing to light allowance on death.
For those in defined contribution schemes the lifetime allowance charge, when it is paid will invariably be 25%. This is a lot to do with the tax changes and pension lump sum death benefit rules that were introduced in 2015 stop it is now possible, as long as your pension contract allows (and many do not) to pass your pension to any nominee that you choose free of any taxation in addition to the lifetime allowance charge this means there is no inheritance tax from the pension is received by them, and it also means inherited pension fund they receive continues to grow free of income tax, capital gains tax and is it outside their estate for the purpose inheritance tax and not subject to light allowance tax on them the only potential taxation will be the income tax that they will pay, in the same way that the original pigeonholed would have paid, as and when they draw down, if the pension holder was over 75. If the pension holder was under 75 and they died then there is no tax on these pension benefits ever. So the most people even if the light allowance tax charges paid 25% they will enjoy significant tax breaks the other monies (especially inside their estate) would have paid in the lifetime.
Now freezing the light allowance, on the basis that individual expect their pension to grow in their lifetime, even if it’s fully crystallised, will mean that many people will pay an increased lifetime allowance tax charge at the rate of 25%. But whilst people are paying more tax it doesn’t automatically mean that the thing that is paying more tax is in somehow “bad”. Somebody who is earning £40,000 per annum if given a £20,000 bonus, will pay a significant amount of 40% income tax on their bonus. They may be aware that if the bonus was only £10,000 they would only paid 20% income tax that does this mean that the £20,000 bonus is somehow worse than the £10,000 bonus? Of course not!
The same is true for the pensions lifetime allowance and to use a very simple numbers the person with the £3 million pension will have a better outcome than the person with the £2 million pension, and in turn they will have a better outcome than the person with a £1 million pension who pays no lifetime allowance tax at all, even the person the three pension pays the most light allowance tax.
It’s worth thinking what this means from a practical perspective when it comes to financial planning.
Most people who have managed to save, as a combination of their own contributions, those from employer, and the investment growth on top of this a pension fund that is in excess of the lifetime allowance, i.e. over £1 million, will not be hard up in retirement stop I’ve lost count of the number of times people hit by lifetime or any allowance charge is have said to me how perverse is that the government are taxing pensions more heavily when they’re trying to encourage people to savings their pensions stop this is a confusion of two objectives: firstly the government increased taxation pensions as pensions are more abstract and I think they think there are easy pickings. I agreed that tinkering with pensions erodes the trust in pensions which is harmful, but the people do like to be hit by lifetime allowance charges are not people who the government are concerned be falling on state benefits!
Therefore many people that reach their retirement age with pension above the lifetime allowance have already cleared their primary residence mortgage, and have no particular need for the capital sum that the pension provides stop the “25% tax-free lump sum” is restricted, the most people, to the lifetime allowance, but in many circumstances it doesn’t need to be taken on day one this means, as a financial planner, and in a situation where I can provide an individual’s income with every 25% being tax-free, and 75% potentially being subject to income tax. I say potentially subject to income tax, as individuals also have a personal allowance of, in the current tax year, £12,500 stop this means, for the individual with a pension fund in excess of the lifetime allowance that with an income need of, let’s say, £60,000 per annum, I could make a pension withdrawal of 66,666 of which 25% is tax-free the remaining £50,000 will be subject to income tax that because a pension is not subject to national insurance, and the first £12,500 of income is in their personal allowance, the actual tax is only seven are thousand pounds this means for a withdrawal from their pension of around £67,000 then actually got around £60,000 to spend over the course of the whole year. They can then make the same withdrawal for something in the region of 18 years (ignoring inflation increases on the income, and also ignoring inflation increases to personal tax allowances in the lifetime allowance, without paying the light allowance charge and only paying effective tax rate on the income of 10% stop that they may have to pay a 25% recovery charge on the pension due to light allowance at 75 (of the press to speaking is the last lifetime allowance benefit crystallisation event many people seems to me a relatively small matter in the context of the other efficient planning has been done along the way.
Beyond 75 there is no further light allowance tests and whilst there may be no entitlement to tax-free lump sums (depending on how those numbers spin out) the individual has a good outcome if they make the most tax efficient use of their pension benefits.
None the above thinks
The above looks only at the taxation on the output of the pension, and when we consider that many of these individuals would have had income tax relief at 40% or higher rates, and in some cases where an employer offers a salary sacrifice scheme and passes on all of the national insurance benefit, people can see tax relief approaching 75%, i.e. every 1 pound of income they forego in their pay packet 4 pounds is going to a pension.
It’s for the reasons above and I continue to be pension positive, and do not see the lifetime allowance as a barrier to using the pension, in conjunction with other tax efficient and privileged vehicles (for example ices) as a cornerstone in financial planning. I do practice what I preach and continue to make significant contributions to mine pension and whilst I run the risk of hitting the lifetime allowance at some point in the future I’m under no illusion that my financial future will be at its most secure the more lifetime allowance tax I pay, that is the larger my pension fund is at retirement whenever that may be.
Jolly old notes