If you read the Sunday papers you may have seen reports that HM Treasury is considering reducing the pensions lifetime allowance by up to a quarter from £1,073,100 to around £800,000. If this happens, many more investors could breach the pensions lifetime allowance and incur the relevant tax penalties. And this isn't something that would just happen to the mega-rich: many professionals such as NHS and public sector employees in defined-benefit (DB) schemes and employees who have diligently contributed to other types of workplace pensions for decades could fall foul of such a lower limit.
“For example, a DB pension member with a final pensionable salary of £69,566 and 40 years of service would easily accrue a pension of around £34,000 and a lump sum of £104,000, which would breach a lifetime allowance of £800,000,” says Ian Browne, pensions expert at wealth manager Quilter. “And for defined-contribution pensions savers, assuming that the lifetime allowance is frozen indefinitely at this lower level, it is a realistic prospect that someone aged 50 with a pension value of £384,814 [could] hit a limit of £800,000 in 15 years’ time at age 65, if we assume 5 per cent a year investment returns.”
But don’t dig out the forms for opting out of your workplace pension or cancel your monthly direct debits into your self-invested personal pension (Sipp) yet. This is just a report that something is being considered and may not happen. There have been many rumours about raids on pensions over the years which have not been borne out.
Don't miss out on contributions
Even if it's true, the earliest at which it is likely to be implemented is later this year and possibly even further ahead, as the report suggesting a cut to the lifetime allowance says that it would be announced in the autumn Budget. So if you stop saving into your pensions now you will lose months of contributions due to something that may not happen. And even if the pensions lifetime allowance is cut, you may be able to keep some or all of what you saved up beforehand as HM Treasury might introduce protections for existing pots.
“There is always a risk that at some point pension tax reliefs might be overhauled, but the right response to that threat is to make use of them while you can,” says Jason Hollands, managing director at wealth manager Tilney. “In the past, when this has happened people have been able to secure the previous higher allowance by applying to protect their old allowance.”
For example, the lifetime allowance was cut from £1.25m to £1m on 6 April 2016 but pension investors could secure the £1.25m cap by applying for Fixed Protection 2016.
“This was essentially a pledge to cease further pension contributions in exchange for keeping the higher allowance,” explains Hollands.
Individual Protection 2016, meanwhile, enables pension investors to freeze their lifetime allowance at the lower of £1.25m or the value of their pension savings on 5 April 2016. They can continue to make pension contributions but have to pay tax on money taken from pension savings that exceed their protected lifetime allowance.
“So don’t do anything rash – keep on saving into your pensions under the rules in place,” advises Hollands. “When any changes are announced, that is the time to consider whether to continue saving into pensions or protect your old allowance.”
Also don’t forget to use your other tax allowances such as individual savings accounts (Isas) to build up retirement savings alongside pensions – regardless of whether there's a cut in the lifetime allowance. Spreading your savings across various wrappers reduces the risk of cuts or freezes to any one of these. And having the potential to withdraw from a range of different accounts could help to reduce the amount of income tax you pay when you are retired.
Read more on this in this week's Portfolio Clinic and How do I avoid breaching the pensions lifetime allowance? (IC, 18 June 2021).