Pension changes due again in budget.
• Well-off savers warned to top up pensions before Budget
• Apply for protection against cut to £1.25m lifetime savings limit
• Roll over unused allowances for previous tax years.
Millions of savers are about to get walloped by pension tax changes that could slash their retirement savings by tens of thousands of pounds.
High earners in particular are being warned to overhaul their arrangements and bung as much into their pensions as possible up to current tax limits, to avoid losing valuable benefits before the Budget on 16 March.
The big threat is that Chancellor George Osborne will introduce a ‘flat rate’ system, under which all taxpayers receive the same level of pension tax relief regardless of how much they earn – ditching the principle that everyone saves for retirement from untaxed income.
Meanwhile, previously announced measures also mean dramatic cuts in how much the better off can save, both annually and over their lifetime, without having to stump up tax.
There are nearly 4million people in the UK who pay income tax at the 40 per cent or 45 per cent rates and nearly 26million who pay the basic rate of 20 per cent, according to data from the Office for National Statistics in January 2015.
I explain below what is happening to pensions, who will be hit, and what can you do to mitigate the damage. But deciding the best course of action will often be a matter of fine judgement, depending heavily on your personal circumstances.
Lifetime allowance: Total amount you can save without a massive tax bill is falling.
What is it?
The lifetime allowance is the total amount people can put in their pension pot during their lives and qualify for tax relief. It is currently £1.25million. What’s happening?
The present plan is to cut the LTA from £1.25million to £1million from the 2016-17 tax year, and index-link it to inflation from 2018-19, but this could be revised as part of any wider shake-up.
A pension pot of £1million sounds like a lot to most people, but it is very possible that many people in their 20s and 30s now might eventually hit it. A £1million pot will also only secure an income of about £27,000 a year for someone with a defined contribution pension.
Darren Laverty, partner at employee benefits specialist Secondsight, says: ‘Taking into account an annual growth rate of 5 per cent, any individual with a fund currently worth £358,000 with 20 years to go until retirement is likely to hit the £1million ceiling. Similarly, someone retiring in 15 years with a pension pot today of £463,000 could also be affected.’
Laverty also warns most ‘death in service’ benefits paid out by employers will count toward the lifetime allowance, a factor which could unexpectedly leave a bereaved family with a much lower sum once the tax is taken.
What can you do?
If you are concerned that you could be caught out by this new rule, you can apply to HMRC for fixed protection, individual protection or both at once in order to keep the current £1.25million allowance after April.
But be warned there are conditions attached and you need to weigh up the pros and cons of each option carefully, because which one is best for you depends on your personal circumstances and future financial planning.
Fixed protection: You can apply for this no matter what the current size of your pension pot, but you will lose it if you ever make any further contributions.
This includes receiving any further ‘death in service’ benefits, and you should definitely check with your scheme beforehand if you go for fixed protection as your current death benefits could be cancelled too.
If you apply for fixed protection you should cancel direct debits into your pension in advance, as even a small, inadvertent contribution made from 6 April will send your lifetime allowance down to £1million.
For the same reason, you should ensure you opt out of any opportunities to join a pension scheme at either your current job or future ones.
Laverty cautions that losing your fixed protection could trigger a tax liability of 55 per cent on your fund value between £1million and £1.25million – leaving you with a bill of up to £137,500.
Individual protection: You can only apply for this if your pension pot is at least £1million by 5 April this year, but you will be allowed to continue making contributions in future.
If you are interested in this option and your pot is currently below £1million, there is still time to top it up before then.
Meanwhile, people who had a pension pot of £1.25million in April 2014 were given three years to apply for protection against the last cut in the lifetime allowance, which was reduced from £1.5million at that time.
Walker says there is still time to claim this higher protection if you haven’t already as the deadline is the end of the 2016/2017 tax year.
Applying for both fixed and individual protection: Your pension pot must be above £1million and you cannot make any further contributions if you want both protections.
Pursuing this option offers you a failsafe if your pension is between £1million and £1.25million. If you lose your fixed protection for some reason, the individual protection means your lifetime allowance will be fixed instead at whatever level it was on 6 April 2016.
That’s unless or until the Government raises the Lifetime Allowance above £1.25million again at some later date, something which is fairly likely given the probable impact of inflation on the size of pension pots in future
For more help and advice please do not hesitate to contact me.