Does Your Pension Need Protection
From April 2016 the Lifetime Allowance or LTA (the amount you can build up in pension savings before additional tax charges apply) is reducing again from £1.25 million to £1 million. It was originally £1.8 Million and has steadily reduced since 2012.
You may think that this is an issue which only affects the very wealthy. The reality, however, may be very different, particularly if you have (or had) a lengthy period of service in a defined benefit pension scheme such as the Teachers’ Pension, Civil Service, Armed forces, NHS or Local Government Pension.
The LTA for a defined benefit scheme is calculated by multiplying the pension entitlement by a factor of 20. If a lump sum is payable in addition to the pension this is added to the calculation. Consider the case of an individual with 30 years’ service in a 60ths pension scheme with a pensionable salary of £100,000. Their pension entitlement is £50,000 per annum which is equal to £1 million (20 x £50,000) for the purposes of the LTA calculation. Any additional benefits from former employment, personal pensions or AVCs will mean that they will be over the LTA after April of this year.
Pension benefits are tested against the LTA when you take them and at the age of 75. The tax payable depends on how you take them:
Lump sum benefits in excess of the LTA will be taxed at 55%.
Income benefits in excess of the LTA will be taxed at 25%.
There are ways of protecting your benefits but great care must be taken to ensure that you apply for the right type of protection and that you do not invalidate it in future years:
Fixed Protection 2016 will allow you to keep your LTA at £1.25 million but only if no further pension contributions are made by you or for you after 5th April 2016.
Individual Protection 2016 is available if you have pension savings worth more than £1 million on 5 April 2016. You may protect your LTA at the value of your pension savings, i.e. if your pension savings are valued at £1.1 million on 5th April 2016 you may protect your LTA at £1.1 million going forward. You may also continue to accrue additional pension benefits without invalidating your Individual Protection.
The purpose of the LTA charge is to cancel out (above certain limits) the tax-exemption on income and gains which pension schemes offer. Many people have chosen to “opt out” of pension schemes rather than exceed the LTA but this is rarely a sensible option. It is important to consider the net benefit (after all tax and charges) relative to the net cost. The significant benefit of employer contributions (particularly in the case of defined benefit schemes) will usually mean that an employee is still well ahead even if an LTA charge is likely to apply.
This is an area where competent, professional advice is essential.