If you’ve been saving into a pension throughout your working life, you might be closer to the Lifetime Allowance than you think. Going over the threshold could mean facing additional tax charges on your future income and, as a result, some members are opting to leave their scheme. However, that’s not always the best option.
What is the Lifetime Allowance?
Currently set at £1.03 million (2018/19), the Lifetime Allowance is the total amount you can save into pensions over your life. It can seem like a figure that’s far-off, but when you consider you’ll likely be paying into a pension for four decades, along with employer contributions, tax relief and potential investment returns, the value of your pension can be larger than expected.
What happens if you exceed the Lifetime Allowance?
You can legally exceed the Lifetime Allowance. However, you will need to pay additional tax. If, when you start taking your pension (or reach age 75), the value exceeds the Lifetime Allowance, the excess benefits will be subject to:
- 55% tax if the pension is taken as a lump sum
- 25% if withdrawn as an income
With this in mind, it’s easy to see why some employees are choosing to retire early, reduce hours or opt out of a pension scheme entirely when approaching the Lifetime Allowance. After all, no one wants to pay additional tax on their retirement savings.
It’s a trend that’s particularly evident among high earners and those with Final Salary pension schemes, which typically offer greater benefits than alternatives. It’s a penalty that’s been well publicised for affecting doctors, but it’s also an issue for other earners that have been paying into their pension scheme throughout most of their career.
To account for a Final Salary scheme in your Lifetime Allowance you must multiply your expected annual income by 20. If, on the other hand, you transfer out of the scheme, the Cash Equivalent Transfer value may be quite high and contribute towards a large proportion of your allowance.
Even if you’re approaching the Lifetime Allowance, there are two key reasons to continue paying into your pension:
1. Employer contributions: If you leave your employer’s pension scheme, they will stop paying in too. Depending on your scheme and the level of contributions your employer makes, this could end up costing you money overall. While the tax implications may mean paying into a pension is less tax-efficient once you breach the Lifetime Allowance, it doesn’t necessarily mean all the benefit is lost. Where your employer is contributing at high levels, it may be the case that this offsets the additional tax you pay, and you still end up with more than you put in. It’s crucial to take specialist advice before making any financial decision that may impact upon your Lifetime Allowance.
2. Auxiliary benefits: Before you even consider leaving your pension scheme, looking at the additional benefits on offer is crucial. Some pensions, particularly Final Salary pensions, offer auxiliary benefits that may be valuable to you; leaving the scheme typically means forfeiting these. One of the most common auxiliary benefits is a pension for your spouse, civil partner or dependents. It can provide financial security for your loved ones should you pass away first, it will usually pay out a percentage of your pension or salary.
While avoiding paying unnecessary tax on your savings makes sense on the surface, it’s important to take a balanced approach. Weighing up how the decision can affect your financial security, as well as that of your family’s, now and when you reach retirement is important. In some cases, paying more tax could prove beneficial when you look at the bigger picture.
Options if you leave your pension scheme
While it’s not the right option for all, for some leaving a pension scheme may make the most sense considering their situation. If you decide to move ahead with this, it’s crucial to have a plan in place to secure your financial future. There are other tax-efficient ways to save for your future, such as Cash and Stocks and Shares ISAs (Individual Savings Account).
If you’d like to discuss how your retirement provisions and tax liabilities could affect your wealth, please contact us. We can help you understand if leaving your employer’s pension scheme is the right thing to do in your situation.
Please note: A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation and regulation which are subject to change in the future.
