Without getting too technical, the lifetime allowance is the amount of money you can save into a pension during your lifetime before you get hit with a whopping great big 55 per cent tax charge. It’s currently set at £1.5m but, as of 6 April 2014, will be coming down to £1.25m. As a result it’s going to hit many people hard.
Now £1.25m may not sound like something you need to worry about. That will never affect me surely” Unfortunately, for many of you, it will. Recent research by the self-invested pensions company, Liberty SIPP, showed that the lifetime allowance isn’t simply a matter for the ultra high net worth.
In fact, many savers with good, if not massive pension pots, have a very good chance of exceeding the lifetime allowance. And in many cases, if they’re in their thirties or forties, they will even exceed the lifetime allowance with no further contributions simply as a result of compounding.
Liberty SIPP calculates that a person aged 40 with a pension pot of £500,000 yielding five per cent per annum and retiring at 65, would see their end fund value exceed the current lifetime allowance by £437,000. That’s without any further contributions and would result in a tax charge of £240,350.
OK, a pension pot of £500,000 is well above the average but it is not unusual among higher earners and company directors. That’s the bad news. What’s the good news?
Well, there isn’t any as such. There is no hard and fast way to get round the lifetime allowance although there are some things you can do to mitigate the effects. Effectively, you can set out to ‘plan’ your way around it.
Here are some examples:
- Now is not the time to delve into its intricacies but something called ?Fixed Protection” can help you to mitigate the effects of the lifetime allowance. However, with fixed protection you can’t make any future contributions to a pension pot;
- An ‘Individual Protection’ option is also being introduced from April 2014. This is interesting as it allows members of employer pension schemes to continue to contribute and could suit employees some years from retirement. Its rules, like those that apply to fixed protection, can be complex;
- The other option for higher earners and people with big pension pots is to maximise all their ISA allowances and, if it suits their risk profile, to look at available Venture Capital Trust, EIS and SEIS schemes all of which are very tax-efficient. However, these are high risk so you could lose a substantial chunk of your investment; and
- Owner-managers of companies can also use their spouse to build up a second pension pot – providing they work in the business. Depending on circumstances and tax implications, this could double up the £1.25m pots, or at least add a sizeable second income for the family.
It’s worth noting, of course, that a pension fund of £1.25m at age 65 could still produce a substantial pension, even using a five per cent annuity rate. You’d be looking at circa ?62,500 pa gross. Not exactly small change in your twilight years. But for some it won’t be enough.
One final word of warning. Pensions are highly political these days. In other words, people could plan for these rules and be undone by the tinkering of future governments. It’s wise to try and keep abreast of any changes and, if you’re unsure, speak to your independent financial adviser.
Peter Adcock is managing director of financial services group Adcock Financial