Lifetime Allowance Planning Options25th October 2015
Pension plans are among the most effective ways to save for retirement, thanks to their tax and other advantages. That said, the Lifetime Allowance (LTA) limits the total amount an individual can accumulate and draw under the favourable tax treatment. Any pension savings beyond the LTA are subject to tax of 25% (in case of annuity), or as high as 55% (in case of lump sum).
LTA Drops to £1m in 2016
While the recent pension and tax reforms have been mostly generous to taxpayers, increasing the annual tax allowances and thresholds and making pensions and ISA’s more flexible, the LTA is one area where the changes have gone the other way. Currently at £1.25m, the LTA will decrease to £1m from April 2016, cut almost by half from its 2012 high of £1.8m. This presents many savers (and their advisers) with new challenges.
Should I Continue to Fund My Pension?
Those who find their pension savings already exceeding or soon likely to exceed the new, lower LTA, are facing the big question: Are the benefits of my existing pension plan worth paying the taxes beyond the LTA level? Should I stop funding my pension, give up my employer’s contributions and find alternative ways to save for retirement? The answer, of course, depends on the details.
Pros and Cons of Continuing
Benefits of continuing to fund the pension plan even beyond the LTA are the following:
- You keep receiving your employer’s contributions.
- You will still get tax relief on your own contributions.
- Your pension savings will continue to accrue tax-free until you draw the funds.
The drawbacks are obviously the taxes you will then pay on amounts beyond the LTA.
Pros and Cons of Stopping and Finding Alternatives
While avoiding the LTA taxes, stopping and finding alternatives has drawbacks and limitations too:
Firstly, you may no longer receive employer’s contributions. Some employers may offer an increase in salary or another form of compensation. Your particular pension plan’s conditions and your particular employer’s contributions and alternative offers will play crucial role in making the decision.
Secondly, other ways to save for retirement typically won’t be tax-free either. Besides investing your after-tax income without any reliefs (unlike pension contributions), you will often have to pay taxes on the returns made every year, rather than on the final amount. This will, in effect, make you lose the opportunity to earn any return on the amounts equal to taxes paid in the meantime, which can add up to a substantial amount of money in the end.
Moreover, investing your retirement savings in other assets may incur additional costs, require more management time and make your savings too fragmented. Therefore, which particular alternatives are available to you (and their particular conditions) will be another key factor to consider in the decision.
One obvious alternative (or rather a complement) to a pension as a way to save for retirement is an ISA. If you are worried about exceeding the LTA and thinking about reducing or stopping your pension contributions, the first thing you should do is make sure you are always taking advantage of the full annual ISA allowance, currently at £15,240 and likely to further increase in the future. It is after-tax money going into an ISA, but from that point both returns and withdrawals are tax-free.
Another alternative is investing in stocks, bonds, funds or other assets outside a pension or ISA scheme. This lacks any of the tax advantages of the former, but may still be a competitive option for amounts beyond the LTA.
Depending on your particular circumstances and the amounts in question, other solutions, such as trusts, offshore companies or offshore pensions, can be considered. These reach beyond your own retirement and can also address the issues of your family’s protection (in case of your death) and passing wealth to the next generations in a tax efficient way. These can of course become quite complex and professional advice is essential.Share: