Do you need to take action to avoid risking additional tax charges in retirement? When it comes to your pension, you might assume that the more that you can save into it, the better. But that’s not always the case. Once your pension savings reach a certain level, you may need to take action to avoid risking additional tax charges in retirement.
There is a limit to the amount of money you can build up in pensions over your lifetime without triggering a tax charge when you access your retirement pot. Several scenarios can trigger a Lifetime Allowance test, and lead to a possible tax charge, including taking money out of your pension, transferring your pension overseas, or turning 75 without having taken benefits from your pensions.
What is the pension Lifetime Allowance?
Your pension is designed to provide you with money in your retirement, which can be in the form of income or lump sums. But there is an upper limit on how much you can draw from your pension or pensions in your lifetime, and if you exceed it, you’ll pay an extra tax charge that can be very expensive.
This upper limit is called the Lifetime Allowance, and it is currently £1,073,100 in the tax year 2021/22 (the UK tax year starts on the 6th April each year and ends on the 5th April the following year).
The Lifetime Allowance was expected to rise in the 2021/22 tax year, as it did in the previous three tax years. But instead, the Chancellor announced in Budget 2021 it would be frozen until at least 2026. This could mean that more people will face the extra tax charge in the future, as they are more likely to exceed the Lifetime Allowance.
How much is the Lifetime Allowance tax charge?
Once you exceed the pension Lifetime Allowance, any further withdrawals you make from your pension will be subject to an additional tax charge of 25% (if taken as income) or 55% (if taken as a lump sum).
Obtaining professional financial advice is essential to ensure you have in place a withdrawal strategy to minimise the amount of tax you may have to pay.
How can I avoid the Lifetime Allowance tax charge?
If you are currently contributing to a pension that is projected to reach a value of £1,073,100 in the future, one way to avoid the tax charge is to stop contributing. This will help you keep your pension value below the upper limit – although your investments could still continue to grow.
While you may be able to avoid the tax charge if you stop contributing, there are potential downsides. One of the biggest is that you may lose out on matched employer contributions. If, for example, your employer matches 100% of your pension contributions, you have more to gain by continuing your contributions than you’ll lose later in tax charges of up to 55%.
To avoid the Lifetime Allowance tax charge but not losing out on your employer contributions, you could discuss your options with your employer. They may be able to offer you additional salary instead of your pension contributions.
Then, you can consider how best to invest this money if not in a pension. There are other alternative options, and the best one for you will depend on your other current financial arrangements.
How can I protect my pension savings?
If you have been a member of a registered pension scheme since 2016 you may be eligible for protection that gives them a higher Lifetime Allowance limit. There are two types of protection schemes available, these are known as Fixed Protection 2016 and Individual Protection 2016.
If you have not made any pension contributions or built-up benefits in a final salary scheme since April 2016 you can register for Fixed Protection 2016. This scheme allows you to lock into a higher Lifetime Allowance limit of £1.25 million.
If you have made pension contributions since April 2016 and your pension savings were over £1million on 5 April 2016 you can register for Individual Protection 2016. This scheme allows those who had exceeded the current Lifetime Allowance limit before 2016 to have a higher limit to cover the excess funds, which is capped at £1.25 million. However, only the funds exceeding the current limit before April 2016 will be protected.
A PENSION IS A LONG-TERM INVESTMENT NOT NORMALLY ACCESSIBLE UNTIL AGE 55 (57 FROM APRIL 2028). THE VALUE OF YOUR INVESTMENTS (AND ANY INCOME FROM THEM) CAN GO DOWN AS WELL AS UP WHICH WOULD HAVE AN IMPACT ON THE LEVEL OF PENSION BENEFITS AVAILABLE. YOUR PENSION INCOME COULD ALSO BE AFFECTED BY THE INTEREST RATES AT THE TIME YOU TAKE YOUR BENEFITS.
THE TAX IMPLICATIONS OF PENSION WITHDRAWALS WILL BE BASED ON YOUR INDIVIDUAL CIRCUMSTANCES, TAX LEGISLATION AND REGULATION WHICH ARE SUBJECT TO CHANGE IN THE FUTURE. YOU SHOULD SEEK ADVICE TO UNDERSTAND YOUR OPTIONS AT RETIREMENT.