This limit will come into effect at the turn of the 2015/16 tax year. It hasn't caused much of a reaction because few people are implicated by the change; however, for some, the reduction could be the catalyst for some big decisions.
Only a few years ago, pension savers could amass £1.8 million in their pension, but this has been cut on a regular basis and will soon sit at a little over half this amount. Breaching this maximum causes a tax charge of 55% if the excess funds are drawn as a lump sum or an extra 25% tax on top of your normal rate if drawn as an income. The Government have offered pension savers a small olive branch by saying that the lifetime allowance will be linked to inflation from 2018 onwards but it will take a long time until it even reaches the current level of £1.25 million.
Most at risk - possibly without realising it - are the higher-earning public servants such as doctors, university professors, and the higher echelons of the police force. Many will now have to make the difficult decision of whether to opt out of their final salary pension plans, retire (if they are over 55), or hope for the best and take the potential hit. The maximum pension they will be able to build up at retirement will be set at £50,000 – before any tax-free cash is drawn.
It will also be decision time for anyone who is relatively young and has a sizeable pension fund. Many people have amassed sums of £500,000+ by their early 40s and, in their cases, an average growth rate of, say, 7% per annum could see them sitting with funds over the (albeit RPI-linked) lifetime allowance by the time they are able to draw their benefits. It should also be pointed out that if someone did opt to purchase an annuity with a £1 million pension fund, at the age of 55 this would buy them an inflation-linked income of under £25,000 per annum.
I have always suggested to clients that they see pensions as a means to wipe out their highest rate of income tax (if they can afford to do so) and balance this with maximising their savings to ISAs. Although ISAs do not benefit from the initial uplift of the tax relief, they can be drawn at any time and, unlike pensions, any income drawn is completely free of income tax.
It is expected that the Government will allow savers to “protect” any sums already built up in the same way as they have with previous cuts. The pay-off will be that you are unable to continue contributing to your pension. The position will have to be closely monitored and, for some, it does seem to be a tax for successful saving or, indeed, a successful investment strategy.
For help with your pension planning, please contact us.