This month Mitch Hopkinson, a winner of the Financial Adviser, a Financial Times publication, ‘UK Independent Financial Adviser of the Year’ award, looks at the impending reduction of the Lifetime Allowance (LTA), coming into effect on April 6 this year. The significant drop in LTA from £1.5m to £1.25m could have a catastrophic effect on pensioners’ retirement incomes – many more retirees will be affected than might be expected.
Planning for retirement is usually top of most people’s priorities. Working hard and saving money to fund your old age is usually the ultimate financial goal. However, the drop in Lifetime Allowance from £1.5 million to £1.25 million in April could result in potentially half of your pension pot being taken away in tax if you are in breach of it. This reduction could, in effect, destroy pensioners’ golden years and enforce a crippling change in retirement plans.
You may find that you are suddenly worse off to the tune of £250,000, and indeed be eligible to pay more tax, at a rate of up to 55 per cent.
Seeking the advice of an independent financial adviser before the reduction in the LTA comes into effect, could help to sidestep potentially shattering consequences.
However, it is highly likely that the change in the Lifetime Allowance on April 6 will adversely affect hundreds of people.
Many people will not know that they have a problem in the first place, as it is up to them to know that the problem exists and take action. If you fall into any of the below categories, then it may be time to seek advice: 1. You are still in a Final Salary Pension scheme (which you have been a member of for some time, over 20 years) and you are earning over £50,000 – so this will be relevant to senior teachers, doctors, dentists, consultants and other senior public sector workers. It’s not just high net worth individuals who will be affected, but also middle income earners too.
2. You have over 20 years in a final salary scheme which you have now left and you have been saving in to a pension since then.
3. You have a large pension scheme and are about to retire.
4. You have a pension scheme that is over £1.25m.
5. You are retired and have a pension income of £60k or more, and you have some other pensions that you have never got around to taking.
The Lifetime Allowance for pensions falling from £1.5m - £1.25m is something that may well have a negative effect if any of the above are relevant to your financial situation. Before the LTA was introduced in 2006, people could have huge pensions and not get taxed – other than on the annual income received. Tax fee cash was exactly that; a lump sum at retirement that was non-taxable.
On reaching retirement, you get a Pension Commencement Lump Sum (PCLS), as well as your income. Both are now taxable. The latter via PAYE, so the most you could pay is 45 per cent. However, when you retire, if you are fortunate enough to have a large pension then you could end up paying 55 per cent when you take your PCLS – this is because if your fund is above the LTA, then the amount above this is subject to tax at 55 per cent (that’s why it's not called ‘tax-free cash’ now).
Many people may think it is not something they need to worry about, but in reality, the reduction in LTA will affect more people that first thought. The reason for this is that for those in old style pensions (or who were in them), the method of calculating their value is to multiply the income they produce by 20.
So, someone who expects to have an income of over £60k from one of these pensions is already getting close to the new limit.
If this is ringing alarm bells then you really need to take some action. Retirees can elect to have 'fixed protection' - this basically freezes the LTA at £1.5m, thus saving you from the reduction. However, there is a catch, you cannot continue to 'accrue' more service (for those in a final salary scheme) or pay in to your pensions (if you are in the money purchase category). Anyone in this situation should look in to their circumstances more closely. It is the member of the pension that is responsible for electing for fixed protection (not the provider nor even the employer). This will mean that many people could forget to do this or not even look at their circumstances in the first place.
People work hard all their lives in order to fund a comparable, or enhanced, lifestyle when they hit retirement age. This change in Lifetime Allowance could ruin even the best-laid plans, leaving many retirees with a greatly reduced nest egg to see them through their old age.
The importance of consulting a wealth management professional has never been more prominent. There are less than two months to go until the LTA reduction comes into effect, and your retirement is far too important to delay taking action.
Mitch Hopkinson is a managing partner of deVere United Kingdom, part of the deVere Group, one of the world’s largest independent advisers of specialist global financial solutions to international, local mass affluent, and high-net-worth clients, through a network of 70 offices across the world and more than 1,200 staff. It has in excess of 80,000 clients and $10bn under advisement.