Protect your pension from new £1.25m limit

TAX TIP: Investors with large pensions should sign up for fixed protection and save themselves up to £137,500 in tax

February 11, 2014

In April the lifetime allowance for pensions will drop to £1.25m, meaning pension investors over or near the new limit have two months to protect their pension and save thousands of pounds in tax.

People who have already accumulated pension funds worth more than £1.25m, or who expect to, can elect for 'fixed protection 2014' with HMRC by 5 April 2014. This preserves the previous lifetime allowance of £1.5m.

Funds in excess of the lifetime allowance will attract tax charges of 55 per cent if taken as a lump sum, or 25 per cent if taken as income. This is on top of any tax payable on the income in the usual way. According to financial planners at Smith & Williamson, electing for fixed protection could save an individual up to £137,500 in tax on excess pension funds between £1.25m and £1.5m.

A 49-year-old with a £500,000 pension fund could hit the £1.25m lifetime limit by the time he is 65, if his investments grow at 6 per cent a year.

If you are a member of a final salary pension arrangement, then to calculate the value for the lifetime allowance, you need to multiply the annual pension due from any final salary pension by 20, and then add any additional tax-free cash.

If you are expecting a final salary pension of £53,000 a year plus a tax-free lump sum of £212,000, then you would breach the £1.25m lifetime limit. Alternatively, if you are expecting a final salary pension of £62,500 only, then you would breach the new limit.

The lifetime allowance was introduced in April 2006 at £1.5m and gradually increased to £1.8m by tax year 2010-11. However, it was reduced back to £1.5m on 6 April 2012, with a further reduction to £1.25m to take effect on 6 April 2014.

Pensions funds are measured against the lifetime allowance when taking benefits, on death prior to drawing benefits, on transfer to an offshore pension, and at age 75 if a lifetime annuity has not been bought with the fund.

Individuals who are currently receiving income through pension drawdown may have already had the value of their arrangements assessed against the lifetime allowance, but this will be subject to a further test at age 75 and therefore consideration still needs to be given as to whether fixed protection is required.

In order to register for fixed protection, you have to stop contributing to pensions after 5 April 2014, and cease to accrue further benefits in your employer's pension scheme. Alternatively, individuals who want to continue contributing to pensions - for example, because their employer makes contributions on their behalf and they don't want to miss out on this perk - can opt for 'individual protection 2014'.

You can hold both fixed protection 2014 and individual protection 2014 but you can't apply for them at the same time.You'll be able to apply for individual protection 2014 from mid-August 2014.

Even if your pension savings are below the £1.25m mark right now, it is quite possible for someone in their 30s or 40s to have amassed pension savings of over £1.25m by the time they retire. The table below shows how many years it would take for a pension fund to exceed £1.25m assuming no further contributions are paid.