Millions of people save into a pension and in doing so they benefit from paying no Income or Capital Gains taxes on the money as it grows. To provide an incentive to save for retirement the Government provides 20% tax relief on personal contributions, but higher and additional rate tax payers benefit the most as they can obtain additional tax relief at their higher rates, not just at the basic rate.
Those who have accumulated significant pension funds need to be aware of the Lifetime Allowance though. This is the limit set on the total value of accrued benefits from all your pension schemes which can be paid to you without triggering additional tax charges. The limit rose marginally in April to £1,030,000, which is the first increase since 2010.
Anyone with a Death in Service arrangement via their employer which is linked to their pension scheme should also note that the value of the lump sum payment on death also counts towards the total value of pension benefits so will also be subject to the Lifetime Allowance limit. Many people in such schemes may unwittingly exceed the limit as a result and if you do breach the Lifetime Allowance a (quite punitive) tax charge on the amount taken above the limit will be payable.
If taken as a lump sum the tax charge is 55%, or if it’s taken as income this reduces to 25%. The income payment is also subject to Income Tax at your highest marginal rate, so an additional rate tax payer could end up paying 70% on income taken in excess of the limit. At the point of withdrawal, should you pay tax at a lower rate than you did previously, this route would be more beneficial from a tax perspective.
You can leave the amount above the Lifetime Allowance untouched of course and this would enable you to pass the residual fund legitimately and tax-efficiently to the next generation.
If you die before your 75th birthday the excess is taxed at 25% (as it’s still above the Lifetime Allowance) but it passes to your nominated beneficiaries tax free (assuming it’s done within two years of your death) and, importantly, that the pension arrangement offers this option. Many schemes do not, despite the rule changes introduced in April 2015.
If you die beyond age 75, rules mean that the same 25% Lifetime Allowance tax charge is applied on the excess. There’s also a Lifetime Allowance test at age 75 but no further tests will be made in the future, even if you live to 100. The nominated beneficiaries would be taxed at their marginal rate of income tax when they commence withdrawals, but if planned correctly this could be passed to non-taxpayers such as grandchildren and may even be used for school or university fees planning.
If you have any queries about the Lifetime Allowance and how it could effect you, get in touch with Steve.
