Pension options explained as Sunak’s pension lifetime allowance rule change takes effect

Pensions ‘shouldn’t be a government piggy bank’ says Altmann

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Chancellor of the Exchequer Rishi Sunak announced a freeze to the lifetime allowance for pensions earlier this year, as he delivered the Spring 2021 Budget. It means the pension lifetime allowance will remain at £1,073,100 for five years, rather than rise according to the Consumer Price Index (CPI).

Recently, there have been reports of possible further changes to come, as the UK Government looks at ways to cover the cost of the increase in public spending due to the coronavirus pandemic.

Prior to these reports, there has been a surge of enquiries from people concerned they will exceed the limit, according to the wealth manager Brewin Dolphin.

The wealth manager said while the short-term impact is likely to be relatively low, equity markets delivering strong returns and the UK’s recovery taking hold could mean more people approaching retirement will be affected in time.

UK Government estimates suggest 95 percent of savers approaching retirement would be unaffected.

However, Government figures also show the number of people exceeding the limit has generally risen over the last decade or so.

The latest available data, for instance, shows more than 4,500 charges were paid in 2017/18.

Tom O’Brien, financial planner at Brewin Dolphin, said: “We have seen a noticeable increase in questions about the lifetime allowance since the announcement that it would be frozen till 2026.

“Savers have done the calculations and markets going up combined with a five-year freeze have provided a double whammy.

“Many people are realising that if they have another good year in that time – or even a few mediocre ones – they could be in line to breach the limit.

“This is particularly the case for those who have deliberately not touched their pension since the 2015 changes, which meant a pension could be passed on tax-free as inheritance.”

Amid the uncertainty, Mr O’Brien has answered a number of questions on the topic.

So, what happens when you go over the lifetime allowance?

“If you exceed the £1,073,100 threshold, nothing happens immediately,” the financial planner explained.

“It doesn’t become an issue until you are tested – which can come about in thirteen ways.

“However, for the majority of people it will be at one of two junctures, whichever happens first.

“The most common is when you ‘crystallise’ – or start to draw on – your pension pot; while the second could be when you turn 75 years-old, at which point HMRC will automatically check.

“There are other quirks in the system to watch out for. If you received a final salary pension and started drawing on the benefits from 2006, you will never have been tested against the lifetime allowance.

“HMRC will take the income you receive every year and multiply it by a factor of 25 which could result in a nasty surprise for some pensioners – particularly if they also have a SIPP.”

What are the options?

“If your pension looks likely to exceed the lifetime allowance, you have a few options to choose from,” Mr O’Brien said.

“There is a lot of debate over the best approach to managing this type of situation, but broadly speaking it boils down to personal circumstances and how you want your retirement to take shape.

“This is one of the reasons why we would always recommend taking financial advice.

“If you are on the cusp of retirement and need to draw on your pension pot, then you could crystallise the benefits almost up to the lifetime allowance limit.

“You can then add more if and when the threshold begins to rise again although contributions may be capped.”

For those who aren’t intending to retire for some time, other choices may be out there.

“If you have a bit more time before retirement, there are other options,” Mr O’Brien said.

“The first, and perhaps simplest, is paying less than you had planned into your pension.

“You may also want to look at alternative options, such as paying into your spouse’s pension pot, or your children’s.

“Another option could be exploring higher risk products, such as Enterprise Investment Schemes (EIS) or Venture Capital Trusts (VCTs).

“These offer tax relief to savers and place your savings in investment vehicles which invest in smaller risk companies, where the rate of failure is high – we would only suggest these for sophisticated investors.

“Another option would be to re-adjust your risk profile.

“You do not have to leave a £700,000 pension pot growing at five percent for too long before it will reach £1,073,100.

“As long as the lifetime allowance was keeping pace, it wasn’t an issue – but, with the limit frozen for five years, it will quickly catch up on you.

“For those taking even higher risk – and receiving a greater return of, say, 10 percent – they may only actually be making a fraction of that figure after tax, fees, and other associated costs.

“They could cut their risk profile, reduce their chances of significant losses, and have fewer sleepless nights.”

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