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Reduction in Pension Lifetime Allowance from April 2016

The Lifetime Allowance is the total amount which can be held within a pension scheme without incurring a tax charge when crystallising the fund or reaching age 75. If benefits are valued in excess of the allowance at either of these points, the excess monies are taxed at either 55% if taken as a lump sum or 25% if left within the pension arrangement. These tax charges are not to be confused with the changes to pension death benefit tax charges announced last year.

The trend in the value of the allowance has been downwards from its peak of £1.8 million in 2011/12 and has been significantly reduced in subsequent tax years to the current level of £1.25 million.

The current allowance of £1.25 million will remain until the 2016/17 tax year at which point it will be reduced to £1 million. This reduction will bring significantly more people into the taxable environment at the point of taking retirement benefits; this is especially true for those with benefits within final salary schemes and will mean that the maximum pension payable from these schemes without a tax charge will reduce to £50,000 per annum.

As was the case with previous reductions in the allowance, it is expected that transitional protection will be available. However, although the details of how this protection will function are not yet clear, it is suggested that only those with pension benefit already in excess of £1 million will be able to apply for the protection. If this is the case, it differs significantly from the previous fixed protections whereby individuals could fix their Lifetime Allowance at the protected level if they believed that their pension funds would breach the limit in the future.

If, as indicated, the protection will only allow those with benefits already over the reduced limit to apply, this will likely mean that considerably more individuals will eventually breach the allowance. This is especially true for those not yet of pensionable age but who have already accrued significant pension funds; for these individuals, it is possible that even if they plan carefully not to overfund their pensions, investment growth alone could result in considerable tax charges at retirement.

These changes mean that careful planning will be essential, particularly around the payment of large contributions and investment returns. If a coherent strategy is not in place it is likely the more pension investors will unwittingly incur tax charges at retirement, negating the tax relief originally received on the contributions.

Finally, a further announcement related to the future direction of the Lifetime Allowance. From April 2018, the allowance will rise each year in line with the increase in CPI. Clearly however, the monetary effect of these future increases are negligible when compared to the reductions in the allowance.

 

 

Date: 19th March, 2015
Author: Michael Lapham

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