How can those on the LTA threshold protect their pension or mitigate its effects?
Apply for Fixed Protection 2016
If you haven’t paid any premiums into a pension since 05/04/2016, you can use the LTA that applied then of £1.25m.
Apply for Individual Protection 2016
If the total of all of your pensions was at least £1m as at 05/04/2016, then you can have a personalised LTA equal to the lower of the value of your pensions or £1.25m.
Take the maximum tax free lump sum available
Some defined benefit pension arrangements (also known as final salary schemes) will pay a tax-free lump sum in addition to the annual pension income.
In certain circumstances it may be possible to opt to take a higher tax-free lump sum (subject to certain limits) and this has the effect of lowering their pension entitlement.
The lowering of the pension entitlement means that the value of the pension benefits tested against the LTA will be lower when multiplied by a factor of 20. The tax-free cash figure is taken at face value in the calculations, thus resulting in a lower overall value than if the standard level of tax-free cash had been taken.
Continue to save into a pension even if your pensions are in excess of the LTA
Stopping paying in would seem logical but that would mean missing out on the tax free growth on a pension fund and potentially missing out on valuable pension premiums from your employer. By stopping paying, you might be worse off financially than paying the tax on the excess over the LTA.
Most defined benefit schemes will reduce the level of your benefits if your start drawing them before the normal retirement age for the scheme. Lower pension income may keep your pension below the LTA and thus avoid a tax charge.
Defined contributions (or money purchase) schemes have a value that is tested against the LTA rather than the pension income figure. In theory, the earlier you take your pension benefits, the lower the value will be as less premiums will have been paid in. This could help keep your pension below the LTA and thus avoid a tax charge.
Defer taking your pension to after age 75
The LTA doesn’t apply after the age of 75 (*). As long as your pension is less than the LTA and you haven’t drawn any of it by the age of 75, you can leave it invested and hopefully to continue to grow, as it won’t be tested against the LTA. You would of course need other income to live off. The option of deferring taking any pension benefits beyond the age of 75 can also be part of a financial plan to pass on your wealth after your death.
(*) If you are in receipt of a defined benefit pension at age 75, an exceptionally high increase on it would be tested against the lifetime allowance, although this is rare.
How will you know whether you will fall into the LTA category?
It can be really difficult to know if you are close to or above the LTA, especially with many people having several pensions and the complexity of obtaining the relevant values.
A review of your overall pension planning by a registered independent financial adviser will identify if there is an LTA issue to consider, in addition to making sure that your existing pensions are invested correctly, are suitable policies and whether or not you need to make any changes to your pension planning in order to meet your retirement goals.
What is the difference between private sector and public sector schemes?
Private sector schemes
- These tend to be defined contribution or money purchase schemes.
- In most cases both the employee and the employer contribute a certain percentage of earnings each month (#).
- The premiums paid purchase units in pension funds and the value of these funds grows over the years.
- There is no guarantee as to the value of the pension fund at a particular date in the future.
- Once the policyholder is old enough (currently aged 55, increasing to 57 in April 2028), a tax free lump sum equal to 25% of the pension fund value can be taken.
- The remaining 75% can be used to purchase a guaranteed income for retirement (an annuity), or it can remain invested in a pension and an income taken as and when required and at the level needed.
(#) Minimum premiums currently are 3% from the employer and 5% from the employee, based on Qualifying Earnings (the earnings that fall between the lower & upper NI thresholds: £520 – £4,189).
Public Sector schemes
- Many public sector pensions are defined benefit pensions, which means the amount they’re worth on retirement is based on your final salary and the length of your employment rather than the amount you’ve paid into the pension.
- Some public sector pension schemes (for example the Local Government Pension Scheme) are funded, but many public sector pensions (including the NHS, teacher and civil service pension schemes) are unfunded defined benefit pensions. This means that they pay retirement incomes from the employer’s current income – tax revenue in the case of the public sector – rather than setting assets aside to pay for pensions.
- These are publicly funded pension schemes which are sometimes referred to a ‘gold plated pensions.
- Recent research carried out by pensions consultancy Lane Clark and Peacock (LCP), show the NHS has the country’s champion pension — with every £1 saved at the start of a career worth more than £10 over a 20-year retirement. The figures are based on the assumption that workers are saving at the start of their career, and stay in the pension until they retire aged 68. The calculations also take into account income promises some schemes make, as well as tax relief on pension savings, employer contributions and investment returns.
What would changes to the LTA do for the pensions industry as a whole?
The LTA has been set at £1,073,100 until 2026 which makes calculations on the LTA easier for the next 5 years and allows for certainty of retirement planning.
A significant increase in the LTA would allow for more substantial pension savings and so increase funds under management as well potentially an increased need for financial advice.
A decrease in the LTA would mean more people would potentially breach the LTA, giving rise to potential tax charges when they had based their retirement plans on the current LTA limits / rules.
Any changes to the LTA will inevitably lead to further complicated protection rules having to be put in place, which impacts on pension policyholders and advisers as existing financial plans would have to be overhauled.
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