What should savers do if the pension lifetime allowance falls to £750k?
Off the back of reports the Treasury’s toying with the idea of cutting the lifetime allowance to £750k down from the £1m due to come into effect in April – Yourmoney.com speaks to pension experts to find out if there’s substance to the headlines and what action savers need to consider now.
What is the lifetime allowance?
The lifetime allowance is the maximum pension savings you can build up without a tax charge over your lifetime. It is currently £1.25m but is set to reduce to £1m on 6 April 2016.
What are the proposed changes to the lifetime allowance?
It has been reported that the government is considering a move to reduce the lifetime allowance to £750k and to restrict the annual contribution from £40,000 to £10,000 in a bid to reduce pension costs.
Yourmoney.com asked the Treasury whether the reports were correct and were told it was based on “speculation”.
Without an absolute denial, Yourmoney.com spoke to Martin Tilley, director of technical services at Dentons Pension Management, Claire Trott, head of pensions technical at Talbot and Muir, and Tom McPhail, head of retirement policy at Hargreaves Lansdown to get their reactions and tips for savers.
For Tilley and Trott, a further cut is “unlikely” given the announced reduction to £1m has yet to be implemented and Trott adds the lifetime allowance was actually planned to start to increase again in 2018.
Tilley goes on to say that as the government has not been able to record any impact of the latest reduction, a further change would be “difficult to justify at this time”.
However if it were to be another drop, Trott says the implications to an average pension saver could be “significant” while for McPhail, such a move would be “catastrophic”.
Who will be most affected?
The Treasury says the reduction to £1m only affects 4% of the wealthiest pension savers approaching retirement and Tilley says it will begin to bite on far more individuals with current funds of only about £500-£600k as they may not realise that with modest growth and future contributions, they could tip the allowance.
“Individuals should take stock of their current pension values bearing in mind the stock market falls to date and build in possible future growth and both contractual and voluntary additional contributions between now and their scheduled retirement date,” he says.
Trott says those with money purchase pension schemes will be hardest hit as they need to have significantly larger pension funds in order to have the same benefits as those in a final salary scheme (such as death benefit for the spouse of half the pension for the remainder of their life).
This is because final salary schemes take the income payable at retirement and multiply it 20 times, then add on any tax-free payment. “It would only need a pension of just over £37,500 with no tax free payment to take them up to £750k,” Trott adds.
In contrast, a money purchase scheme of £750k would only buy a pension of £36,315 according to the Money Advice Service and will remain level for the life of the annuity, ceasing on death so no payments continue to the spouse.
What can and should savers do now?
For McPhail the answer is easy: “The only thing they can do today is save and invest as much as they can ahead of the Budget and then cross their fingers.”
Trott says the first thing savers should do is to establish how much their pensions are worth and then anyone who’s worried should consider taking advantage of the ‘transitional protections’ issued at each successive drop, adds Tilley.
These protect differing levels of funds and have different restrictions. Tilley says: “If there is a further drop to £750k then precedents have been set for the type of protections that will likely be available and if you are near or at £750k at the point the drop occurs, then it may be something to consider.”
Both fixed protection – fixes to the current level of £1.25m but prevents future contributions being made or any benefit accrual within a defined benefit scheme – and individual protection will be available although it is not possible to apply for them until around July.
In comparison, individual protection requires a minimum fund size of £1m at 5 April 2016, it permits future contributions and protects up to £1.25m
What does the Treasury say?
An HM Treasury spokesperson said: “The reduction of the Lifetime Allowance to £1m only affects 4% of the wealthiest pension savers approaching retirement and the tapered Annual Allowance only impacts 2% of those saving for a pension.
“These changes were announced last year and are coming into force this April. The government launched a wide-ranging consultation to look into pensions tax relief last year. This consultation has now closed. We are considering the responses and will respond in due course.”