Pension pain: Savers who bought lifetime allowance ‘protection’ warned they may still find their tax-free lump sum capped
Chancellor Jeremy Hunt’s decision to scrap the pension lifetime allowance (LTA) in Wednesday’s Spring Budget, was heralded as an incentive for wealthier employees over 50 to stay in the workforce.
But some pensions experts say for those who took out a form of LTA protection may still have to watch they do not go over any allowances, or pay the tax penalty.
Gary Smith, partner in financial Planning at wealth manager Evelyn Partners said the issue arose for those who taken out a life office form of HMRC sanctioned ‘fixed protection’ which would allow them to keep putting money into their pensions even though the government had slowly reduced the cap on the amount they could put in.
The main issue is around the amount of tax-free cash a saver can take as the scrapping of the allowance means savers can put more in and in theory their 25 per cent entitled will grow.
But it appears the amount of tax-free cash will be frozen at £268,275 – which equivalent to 25 per cent of the current LTA.
Smith said the Budget had not made it clear how those who had taken out fixed protection against “historical reductions in the LTA” would retain access to the full tax-free lump sum from their protected pot, or whether they would have to submit to the new capped lump sum of 25 per cent of current LTA.
Smith said someone with LTA protection should “still probably refrain “from immediately renewing pension contributions in the current tax year, as the existing regime is still in place and that could mean they sacrifice their protection, possibly without the benefits of the new regime.
He added that the the tax-free lump sum under the new regime will be capped at an absolute maximum of £268,275 – equivalent to 25 per cent of the current LTA – from the next tax year and thereafter.
This means even without the lifetime allowance cap savers will only be able to take out a maximum of £268,275 before paying tax.
“So many savers with protected lump sums will have been wondering whether, if they resumed contributions to take advantage of the vanished LTA, they would have to give up their protected lump sum and submit to the cap.
“The answer, for the moment, seems to be no – for the next tax year HMRC have said that they will retain entitlement to their protected lump sum.”
Interim pension arrangement
Smith said there was a chance that this could be an interim arrangement, as the details around the new pension rules will not be finalised until a Finance Bill for the tax year 2024/25.
“And there is no guarantee the 2023/24 rule will be carried forward, although it would be troublesome if it wasn’t.”
Labour’s pledge to reinstate the LTA if it gains power after the next General Election has added to the confusion.
Smith said: “While we broadly welcomed the lifting of the LTA, these unknowns are detrimental to forming coherent and robust financial plans, and will make it difficult for some savers to plot the best course of action. We really do recommend that people with pots close to or above the LTA, or who have fixed protection in place, seek advice from a financial planner. “
“Third, HMRC also offered some detail on other sorts of lump sum. From 6 April, lump sum pension benefits in excess of the lifetime allowance which would currently be subject to a 55% charge, will then be taxable at the recipient’s highest marginal rate of tax. “
“So this includes lump sums taken in the case of death or ill health of the pension holder, but also lump sums taken by the saver in excess of the LTA. Under the existing rules, if someone with a pension pot greater than the LTA crystallised the whole pension they would be taxed at 25 per cent if the funds were taken as an income, i.e. placed into drawdown, or 55 per per cent if taken as a taxed lump sum.
Why £250,000 plus is ‘not a lot’ in pension terms
Steven Cameron, of Aegon said while a pension pot of the current limit of £1,073,100 may seem like a lot, a million pound pot will not provide a millionaire’s lifestyle in retirement which can often last for 20 or 30 years.
“Based on current annuity rates, a 65 year old might be able to buy an annuity of £3,700 a month, which is subject to income tax. Also, 12 years ago in April 2011, the lifetime allowance was actually £1.8m. If this had been increased in line with inflation each year, then from April 2023 it would have been almost £2.5m.”
“While Labour may feel that the Lifetime Allowance change will benefit only higher earners, the increase in the Money Purchase Annual Allowance will have much wider benefit across the earnings spectrum and we’d hope would be seen as helpful by all political parties. “
“Many over 55s will have accessed their pension flexibly, perhaps during the pandemic or cost of living crisis.
“If they want to pay future pension contributions, perhaps on returning to the workforce, the previous limit on their and their employer’s contributions of £4000 is very restrictive and could stop many from being able to benefit from their workplace pension, which could discourage some from returning to work at all.
“The increase to £10,000 announced in the Budget makes huge sense and we hope will be here to stay.”