Every UK citizen currently has a Lifetime Pension Allowance. This is the total amount you can save in your lifetime into pensions, work or private, without additional taxes being applied.
Background: An allowance in free fall
The current rate in 2015 is £1.25 million. However, this is set to be reduced to £1 million in April 2016. This is not the first time it has been lowered. Successive governments have seen it as an easy tax raid. The consequence is that it reduces the capacity of high earners to make tax efficient contributions to their pension funds.
When first introduced, the Lifetime Allowance was set at £1.5 million and then increased each year to £1.8 million in the 2010/11 tax year. Since then the allowance has been in free fall as the government has attempted to rein in spending.
Any increases in the Lifetime Allowance in the future are planned to be only by the annual rate of inflation. Current estimates indicate that on this basis the allowance won’t break the previous £1.8 million level until 2036.
So what happens if you exceed the lifetime allowance?
Pension funds are only assessed against the Lifetime Allowance when a benefit crystallisation event occurs. Most commonly, this is when you take a tax-free cash lump sum from the pension, or the pension is entered into drawdown. There is a final longstop crystallisation event at age 75, when all pension benefits are assessed against the Lifetime Allowance.
It is also possible to part crystallise a pension in order to keep any funds in excess of the Lifetime Allowance excluded from assessment for as long as possible until age 75.
Any funds that exceed the Allowance when an assessment is made can be taxed in one of two ways;
1. The excess can be taken as a lump sum and a one off 55% tax charge is applied.
2. The second option is to leave the funds within the pension and pay a 25% tax charge.
What could you do if you incur a charge?
The tax charged is essentially income tax so it may be worth considering making tax efficient investments in the same year to offset the effects of the taxation on the funds. Venture Capital Trusts and Enterprise Investment Schemes can offer tax relief of 30% against income tax paid in the current or previous tax year. These are regularly used in conjunction with excess Lifetime Allowance withdrawals to re-claim some of the tax that would have been paid.
Does this affect you?
The Lifetime Allowance is a complicated topic. Capital Wealth Partners are one of the UK’s leading advisers on this topic. We have an open information policy that allows you to ask questions in order to establish the best way to approach potential Lifetime Allowance charges.
Alexander Ogden is a Private Client Director at Capital Wealth Partners. He is one of the UK’s leading advisers on the pension Lifetime Allowance and high value pensions for high net worth clients. For further information on this topic or on advanced estate planning, he can be contacted at alexander@cwpwealth.co.uk or by phone on 0844 338 6622.