14 September 2015
Changes to the Lifetime Allowances limit are likely to mean more of us paying tax on our pensions, says Stephen Casey.
Is the total of all of your pensions going to be greater than £43,478 per annum with a lump sum? If so, you are very close to going through the Lifetime Allowance set by the last budget. The Chancellor announced in March 2015 that the pensions Lifetime Allowance, which restricts the value of tax-favoured pensions saving an individual can make in his or her lifetime, will fall from £1.25m to £1m from April 2016.
The current £1.25m limit would allow a pension of approximately £54,347, plus your lump sum, without incurring additional tax charges when taking your pension. The reduction in the allowance means that you are allowed to take a much smaller pension before previous tax-relief is clawed back by Her Majesty’s Revenue and Customs (HMRC).
If you have other pensions such as additional voluntary contributions (AVCs), the Teachers’ AVC with Prudential, private pensions or pensions for other companies then the combination of all your pensions counts towards your overall Lifetime Allowance. (The State Pension is excluded.)
The reduction, therefore, will have an impact on many more ASCL members than before.
Calculating your Lifetime Allowance
Your pension pot, for these purposes, is calculated as follows:
Pension Pot = (Annual Pension x 20) + lump sum
For example, a member with a pension of £47,000 pa would have a tax-free lump sum of (3 x £47,000) = £141,000
The size of the pension pot is:
(£47,000 x 20) = £940,000 + £147,000 (lump sum) = £1,087,000
Under the present tax regime the total of £1.087m is less than the limit of £1.25m so the member would have no tax charge. However, when the new limit of £1m comes into effect in April, the member will have exceeded the limit by £87,000. The excess amount will incur a tax charge of up to 55 per cent, depending on your pension scheme. This could amount to a one-off tax bill of £47,850 on taking the pension.
If you are in the Teachers’ Pension Scheme, the tax would be 25 per cent of the excess and is taken from your pension. In this case, the member would have a tax charge of 25 per cent of £87,000, which is £21,750, still a significant sum to pay back. However, HMRC and Teachers’ Pension Scheme (TPS) have an arrangement whereby your pension is reduced by 1/20th of the tax charge. That is: 1/20th of £21,750 = £1,087.50.
Therefore, the £47,000 pension would be reduced by £1,087.50 making a pension of £45,912.50pa plus your tax-free lump sum.
The last time the Lifetime Allowance was reduced from £1.5m to £1.25m in April 2014, HMRC offered protection against the changes to protect existing rights. At the time of writing the fine details of the new protections and how to apply for them had not been announced. However, as was the case when the allowance was last reduced, two forms of transitional protection will be put in place to protect existing rights:
Individual protection – giving individuals their own personal Lifetime Allowance (above the prevailing standard allowance). These individuals can continue to accrue benefits but any benefit in excess of the personal Lifetime Allowance will incur a Lifetime Allowance tax charge.
Fixed protection – allowing individuals to retain a £1.25m allowance but this would be immediately lost if there were new benefit accrual. Unfortunately, HMRC announced in April that the Teachers’ Career Average Pension Scheme is considered a ‘new’ scheme and so some earlier protections may be exempt if the member joins.
If you are approaching your Lifetime Allowance or have exceeded it then it’s important that you get advice about the next steps. You could contact me through the ASCL hotline or our partner at http://simplitax.com
There is some small consolation for this reduction in the allowance with the announcement that it will start to be indexed in line with the Consumer Prices Index (CPI) but only from 2018. However, it is important to keep in mind that the Local Government Pension Scheme increases with CPI while the teachers’ scheme will increase CPI + 1.6 per cent, outstripping the Lifetime Allowance rise.
The repeated lowering of the Lifetime Allowance creates an atmosphere of uncertainty around the stability of the pensions tax regime and may well deter individuals from saving for their retirement through a pension – particularly at a time when the Chancellor is announcing measures to encourage other forms of saving. This reduction, coupled with the reduction of the Annual Allowance (see Leader July 2015) has seen the most senior public sector workers’ pensions being raided for additional tax after many years of service.
Senior leaders are now left wondering if it’s worth taking on additional schools with increased remuneration if it eventually leads to higher tax charges on a decreasing pension pot.
Pensions are still an excellent way of saving, but the reduction in tax relief on contributions and the final pot will lead many to look elsewhere if they are in excess of these much lower limits.
Stephen Casey is ASCL Pensions Specialist
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