Increasing numbers of people are facing substantial tax penalties on their pensions, sometimes unexpectedly. Are you at risk of an unwelcome surprise?
The tax and national insurance contribution reliefs enjoyed by pensions cost the government £53.7bn in 2017/18, according to statistics issued by HMRC in September 2019. It is little wonder therefore that successive Chancellors have attempted to cut back on such levels of generosity.
The most recent attacks on pension reliefs have focused on two key allowances:
- The lifetime allowance sets the maximum tax-efficient value on all your pension benefits. The standard lifetime allowance is currently £1.055 million, after three cuts between 2012 and 2016 reduced it from £1.8m back in 2010/11. The value of pension savings above the available allowance (after any transitional reliefs) is subject to tax at a flat rate of 55% (as a lump sum) or 25% (as income). As of mid-November 2019, for a 65-year-old non-smoking single person, the current lifetime allowance would buy a level pre-tax pension of about £53,000 a year. Add inflation protection and the figure falls to about £29,000. That’s probably not as much as you’d imagine a fund of £1.055 million would provide.
- The annual allowance sets the maximum tax-relievable pension contributions that can be made for you from all sources during a tax year. This is now a standard £40,000 but it started the decade at £255,000. In 2016/17 the tapered annual allowance was introduced, targeting high earners, and reducing their annual allowance to as little as £10,000.
Personal tax relief is effectively clawed back on excess contributions over the available allowance (which can include unused allowance from the preceding three tax years). About one third of the tax payments due is collected as a deduction from the individual’s pension fund, but most is reported and collected via self assessment. There is no special tax treatment for the benefits arising from these contributions, so you could receive no contribution tax relief, but still pay income tax on your eventual pension.
The penal tax charges for breaching the lifetime or annual allowances were probably designed to be more of a deterrent than a revenue raiser for the Treasury. In practice, the charges have proved to be money-spinners for the government. As the graph shows, in 2017/18 over 26,500 people reported contributions exceeding their available allowance, nearly five times the number two years previously. The lifetime allowance charge raised £185m in 2017/18, virtually double what it did two years before.
One reason why these hefty charges are being paid is the complexity of the calculations involved. For example, the amount of the tapered annual allowance cannot be accurately calculated until after the end of the tax year to which it relates.
If you may be affected by either, or both, of these pension tax charges, then it is vital to take advice as soon as possible. Ultimately, you may need to consider some additional alternatives to pensions for your retirement planning.
The value of tax reliefs depends on your individual circumstances. Tax laws can change. The Financial Conduct Authority does not regulate tax advice. The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.