The Spring Budget announced that the Lifetime Allowance (LTA) was going to be frozen at the current level of £1,073,100 until April 2026. Although this may seem like a sizeable allowance, the introduction of pension freedoms in April 2016 has seen an increase in pension millionaires, who perhaps even without realising, could fall into the taxable bracket.
What does this mean for you?
Since April 2018 the Lifetime Allowance has been steadily increasing from its lowest level of £1 million in 2016 in line with the Consumer Price Index (CPI) on an annual basis. The freezing of this allowance will now pave the way for more clients facing Lifetime Allowance tax charges on the excess over the allowance of either 25% plus marginal rates of tax if drawn as an income or 55% if taken as a lump sum.
This may raise the question, should I continue funding? The decision to cease funding will be dependent on individual circumstances and should not be taken lightly.
Important Considerations
| Stopping Funding | Continue Funding |
| You may reduce / eliminate LTA charge | Savings above the LTA will be subject to an LTA charge |
| You may lose the benefit of your employer’s contribution | You will retain the benefit of your employer’s contribution |
| Loss of tax relief / National Insurance* savings on personal contributions | You will still benefit from tax relief / National Insurance* savings on personal contributions (subject to limits) |
*applicable to salary sacrifice arrangements only
Funding and the Lifetime Allowance (LTA) Tax Charge
Although it may seem counter intuitive making a personal pension contribution in the knowledge that there are likely to be additional tax charges applied further down the line, what really matters is what is likely to be left after deduction of taxes.
The table below looks at what a client receiving 40% higher rate tax relief might get back from a pension and an ISA, taking into consideration the LTA tax charge and assuming income in retirement can be kept within 20% basic rate.
| Wrapper | Net Personal Contribution | Gross Personal Contribution | Fund Value @ 10 Years* | LTA Tax @ 25% | Income Tax @ 20% | Net Balance |
| Pension | £15,000 | £25,000 | £33,598 | (£8,399) | (£5,040) | £20,159 |
| ISA | £15,000 | £15,000 | £20,159 | (£0) | (£0) | £20,159 |
*Assuming growth rate of 5% per annum and ongoing charges of 2% per annum, giving a net real return of 3% per annum.
On the face of things in this scenario there is no difference between saving into a Pension or an ISA but the figures do differ depending on rates of tax and there are also further considerations.
Employer Pension Contributions
Where you are making contributions as part of an employer sponsored pension arrangement it is worth checking to see what happens to the employer contribution. Many employers offer matching contributions, which is effectively ‘free money’, meaning that where a worst-case scenario 55% LTA charge applies, receiving 45% of something is better than nothing.
Alternatively, it may be the case that your employer will offer some form of additional remuneration in place of the pension contributions, but much will depend on the associated level of tax and National Insurance that comes with it.
Salary Sacrifice Arrangements
Salary sacrifice arrangements involve an employee agreeing to give up some of their salary or contractual bonus in return for employer contributions thus saving marginal rates of tax at source along with National Insurance.
Opting out of a salary sacrifice arrangement will result in the previously sacrificed amount being subject to tax and National Insurance, resulting in a lower net benefit received in take home pay. In addition to this, there is also the potential of the higher pay leading to the loss child benefit through the child benefit tax charge and the reduction / loss of the personal allowance, resulting in additional tax to pay.
Inheritance Tax
Taking further direct renumeration rather than continuing to pay into a pension could, in the long-term, also have Inheritance Tax implications.
Where sums of money passed on via pensions are generally free from Inheritance Tax, most other personally held funds would form part of your estate for Inheritance Tax purposes.
Lifetime Allowance Protections
One final point to consider is Lifetime Allowance protections. These come in various forms and may offer a higher level of Lifetime Allowance, namely Fixed Protection and Individual Protection.
- Fixed Protection 2016 allows members to keep a Lifetime Allowance of £1.25 million post 2016. There is a trade-off however and there must be no further benefit accrual after 5 April 2016.
For anyone that has an existing valid fixed protection in place, making any new pension contributions or becoming auto-enrolled into their employer’s auto-enrolment scheme would result in the loss of this protection.
While this protection can be extremely valuable, much depends on the point at which you are looking to retire. If we work on the assumption that the LTA is going to continue to increase in line with an assumed CPI rate of 2.50% per annum post April 2026, it will only take 7 years from this point before the £1.25 million limit is breached.
- Individual Protection 2016 is also available to those with pension savings valued in excess of £1 million on 5 April 2016. This protection crucially comes without a trade off as pension funding / accrual can continue post 5 April 2016.
Conclusion
As you can see from the above, there is no ‘one size fits all’ approach and each decision is tailored to personal circumstances and underlying objectives. If you require any further information or would like to discuss any of the points above in further detail, please contact us to discuss further.