The reduction in the pension lifetime allowance from 2014 means many more pensions savers could be heading towards a 55 per cent tax bill, and much more easily than they might expect, according to Buck Consultants. The reduction from £1.8m to £1.25m in the last three years means that planning will be extremely difficult, and the maximum income a pension could buy is just £41,000 per annum*.
Colin Richardson, Senior Actuary, Corporate Consulting, Buck Consultants said: “Our calculations show that people do not have to have a huge pension fund for the change in lifetime allowance to have a destructive impact. Whilst most of the focus since the Autumn statement has been on the new annual allowance of £40,000, we believe the reduction in the lifetime allowance is actually a timebomb. After all, you can calculate if you are likely to go over the annual allowance whereas it’s much more difficult to predict whether your pension pot will infringe the lifetime allowance.”
He continued: “There is also a disconnect between defined benefit and defined contribution pensions in that the maximum defined benefit pension is £62,500 per annum, whilst a maximum defined contribution pot of £1.25 million will purchase around £41,000 per annum – a third less than a defined benefit pension.”
“Furthermore, investment choices may be distorted towards low returning assets for a much longer period prior to retirement for pension savers with a risk of exceeding the limit. This will limit pensions even further.”
According to Buck, the key issue is the inability to plan, because changes to the lifetime allowance have not been accompanied by any statement of future policy intention. The question is: how far below the figure of £1.25m do individuals need to be before they run the risk of an excess at retirement? Buck’s analysis demonstrates how easy it could be to exceed the allowance, and the impact of investment returns and future contributions could lead to a 55 per cent tax charge.
• For someone in their 50s, so 15 years from potential retirement, a fairly modest 6% per annum return would multiply their fund value by 240%. So a current value of £500,000 could come close to the limit, based on a modest return, with no further contributions. However, future investment growth could be anything and the variance could be enormous.
• Allowing for modest future contributions over the 15 years and assuming a 6% per annum return, even a fund today of £225,000 would reach the limit.** Certainly those with funds today between £250,000 and £400,000 will risk an excess if they have 10 to 15 years or more in work prior to retirement.
• For those in their 40s, with 20 to 25 years until retirement, much smaller current fund sizes will face potential issues. The additional five to 10 years of investment returns mean a current fund size of £300,000, with no additional contributions, or £150,000 plus future contributions could hit the limit.
Mr Richardson continued: “These figures demonstrate how easy it is for someone who is making solid – but not exceptional – pension contributions of, say, £10,000 over 30 years to exceed this limit, if starting from no fund at all. Employers and employees need to consider whether employer pension provision needs to be replaced by an alternative type of remuneration if calculations show that an individual risks an excess.
“There is also a problem that the auto-enrolment legislation does not take account of the lifetime allowance. An employee with a lifetime allowance issue, who is subject to auto-enrolment, will still have to be auto-enrolled by their employer. Unless they opt-out within a month they will be saving into a pension expecting to lose 55 per cent of it. Not only does this involve extra administration, it also means that the new pension is ineffective if the individual does not realise that he or she needs to opt out.”
Richardson concluded: “Pensions have been a consistent target in the current fiscal climate, but what we need is stability and predictability for pensions to enable people to be able to plan effectively for their retirement income. Indexation of the allowance is vital because pensions need to be planned, and we believe a long term Government commitment to index the allowance is needed, in addition to re-instating some of the enormous reduction from £1.8m to £1.25m in the last three years.”
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