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How your clients can manage pension Lifetime Allowance issues

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One of the less heralded announcements the chancellor made in his March Budget was that he was to freeze the pension Lifetime Allowance (LTA) until 2026.

With the allowance currently exceeding £1 million, it might be easy for your clients to dismiss it, believing that “it couldn’t possibly affect them”.

However, figures from HMRC reported by This is Money say that 7,130 charges for breaching the limit were reported by schemes in 2018/19, at a value of £283 million, up 6% on the year before. This number is set to rise sharply over the next five years as strong investment returns push more and more people over the LTA.

The LTA is something that could affect many of your clients and breaching it can lead to tax charges of up to 55% on any money withdrawn from pensions above the limit. Read on for information about how the LTA affects your clients, and how they can deal with these issues.

More people expected to be caught by LTA

Pension allowances can be a complex area, even for those with financial acumen. There are currently limits on the tax-efficient savings clients can contribute each year, further complicated by reduced allowances for high earners and those who have already begun to flexibly access their pension.

Commenting on the LTA freeze, Andrew Tully, technical director at provider Canada Life, says: “More and more people will get caught by this relatively arbitrary figure, with the Treasury expecting to raise an additional £1 billion in tax.

“This is a complicated area of pension planning, and it is all too easy to get caught out, so anyone concerned about breaching […] these limits should consult a professional financial adviser.”

The LTA restricts the amount of tax-efficient savings a client can accumulate over their lifetime. It stands at £1,073,100 and has been frozen at this level until 2026.

If a client has a money purchase (defined contribution) pension, then calculating the LTA is quite easy as it’s simply the pension investment fund value.

If it’s a final salary (defined benefit) scheme it’s a little more complex. Here, the equivalent fund size is the annual pension payable multiplied by 20, plus any lump sum that is payable in addition. Pensions taken before April 2006 are valued by multiplying the pension payable by 25.

If a client has a mixture of pension types, they need to be added to work out a client’s LTA position.

LTA charges can be significant

A pension is “tested” against the LTA when a client comes to drawn funds. This is called a “Benefit Crystallisation Event” (BCE) and, just to make things even more complicated, HMRC have listed 13 events that qualify as BCEs.

If your client decides not to draw benefits from a pension, they won’t escape the LTA test. This is because there is a final calculation at age 75 when everything has to be declared and both crystallised and uncrystallised pensions are totalled for the test.

Even if a client dies before they take their pension benefits, it’s still a BCE and so the test will apply. Clients may need to take particular care here, because some life cover associated with pension schemes may also be included in the calculation.

If the value of a client’s pensions exceeds the LTA on a BCE, they are subject to a tax charge of 25% on any income drawn, and 55% on any lump sums taken, above the LTA.

Why the LTA will be an issue for more and more of your clients

Accumulating more than £1 million in pension benefits might seem like a substantial amount for many clients. However, a client expecting to live for 30 years or more in retirement and wanting to maintain a comfortable lifestyle could easily build up a pension pot that size.

Similarly, strong investment returns over a decade or two could also see many people breach the limit. Anyone with a pension pot of £500,000 now will see their fund exceed the current LTA in 20 years’ time, even just assuming 4% annual growth.

Even before the freeze, the LTA was only rising by the CPI rate of inflation. As, historically, pension funds and salaries have grown faster than inflation it is likely that more and more clients will be affected by the issue in the future.

It’s also important to mention that LTA issues can often arise on divorce. Where there are significant pension assets, sharing pensions can see one or both parties end up with a pension that is valued above the LTA. Again, advice can be very helpful in this situation.

Seeking financial advice can help your clients deal with LTA issues

There are several strategies that your clients can employ to tackle LTA issues. These include:

  • Apply for “fixed protection” or “individual protection” – this can protect an individual’s LTA at a higher amount
  • Consider other tax-efficient savings such as ISAs
  • Continue to contribute and pay the 25% tax charge. If clients stop contributing to their pension, they may lose employer contributions, tax relief, and investment growth. When these returns are combined clients could find that they are still much better off – even if they do pay a 25% tax charge.

Advice will be dependent on a client’s specific circumstances, so it can pay to take professional advice. We can model a client’s future enable them to make positive decisions – whether that’s to act or do nothing!

Get in touch

If you have clients that are facing LTA issues, or would benefit from advice, please get in touch. Email hello@sovereign-ifa.co.uk or call 01454 416653.

Please note

A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future results.

The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates and tax legislation may change in subsequent Finance Acts.

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