The UK Government will soon be altering a limit which may have a profound effect on the size of your pension. This move could see your pension pot substantially reduced if no action is taken. Despite the fact that this move was announced a while ago there are still many people out there who are either unaware of the true ramifications, believe they don’t have time to look into the matter, or don’t realise that the charge is avoidable.
What is changing
The Government is altering the level of the lifetime allowance (LTA) to £1 million from April 6th 2016. This cuts the amount that a pension can grow to without being subject to an additional tax charge. It represent a drop of £250,000 from the current limit which, accounting for a potential LTA charge of 55%, could see you being subject to an additional £137,500 tax liability.
Who does the pension rule changes effect
Anyone anticipating a combined pension income in the region of £40,000 per year or more.
Firstly, those currently near or exceeding the LTA limit should rightly be considering all the options available to them. It is important to note that this limit covers a combination of all your pensions so therefore it includes both defined benefit (e.g. final salary) and defined contribution schemes. Since a general rule for the former’s calculation is 25 x annual income the £1 million ceiling amounts to an annual pension of around £40,000. To receive an accurate calculation please contact your pension provider. For the more common money purchase variety, using annuity rates offered as a guide for income in retirement, an expected pension of under £40,000 could still trigger the lifetime allowance charge.
How much time do you have
For those near or exceeding £1 million of pensionable assets you must have all necessary actions completed by end of day on the 5th of April 2016. If the action involves making a pension transfer to a new provider it may already be too late since certain schemes releasing funds have been known to take in excess of 6 months. It is therefore recommended to take action as soon as possible.
For those expecting to receive an income in excess of £40,000 per year in retirement, again, it is best to have all the necessary work done prior to the 6th of April 2016 to allow you to benefit from the current higher levels.
How your tax charge may exceed £137,500
The above figure is not the upper limit to your tax liability. Far from it as it transpires. Due to the lifetime allowance limit being set independently from your pension returns two main factors could have a large baring on you becoming liable for a substantial tax charge: the LTA limit may change and your investments could prove successful.
Over the course of the LTAs existence the limit has varied from £1 million (as of next year) to a high of £1.8m. That £800,000 drop, which will have occurred over a mere 5 years, could result in an additional £440,000 tax bill (at the 55% tax rate mentioned above). This also has the potential to catch a far higher number people within its sphere than before.
Although the changing nature of LTA limits can be planned for the other main factor offers little cover. Consider for a minute that you and your neighbour both save towards retirement via a pension, contributing exactly the same amount over the same timescale with exactly the same provider. How would you feel if you were to learn that, upon drawing your pension for the first time you were to be charged £100,000 in tax whilst, after consulting with your neighbour, you found out that they weren’t going to be liable for any charges? The only difference was that you managed to get higher investment returns, possibly by taking more risk. This hardly seems fair especially considering that pensions should offer tax free gains. Lifetime allowance limits are set based on all one’s pensions combined value rather than the contribution history. Until this changes you will have to be aware of your pensions growth so that you don’t end up paying unnecessary tax.
How you can avoid this tax
It may come as a surprise but this tax is either partially or completely avoidable. By not taking action you are choosing to pay. The one instance that makes the full charge unavoidable is when you contribute to a single British pension plan which is subsidised by your employer who will not allow you to start a secondary pension with them. In all other cases consider the following options.
If you qualify as a non UK tax resident then you are entitled to transfer most UK pension schemes into a non UK based plan, known as Qualifying Recognised Overseas Pension Schemes (QROPS). There are benefits associated with using a QROPS over UK registered pension schemes (RPS). The key advantage in the context of the lifetime allowance charge is that a QROPS transfer triggers a final tax calculation, known as a benefit crystallisation event. This is a unique event for assessment against LTA which ensures that the transferred pension is never again assessed for a potential lifetime allowance tax charge. The result of which means that any further pension growth is not liable for an additional charge
To both keep the existing LTA limit whilst still contributing to your pension, an option not normally available, the same method utilised by non-residents may be adopted by yourself subject to the caveat below, namely making a pension transfer into a suitable Qualifying non-UK based scheme known as QROPS. Though, due to you being a UK resident the pension plan, in essence, will operate in a similar manner to a Self Invested Personal Pension Scheme (SIPP) rather than providing all the advantages normally afforded to these plans. The key point, however, is that the transferred pension will benefit from having the lifetime allowance tax calculation being assessed at the point of transfer only and never again in the future.
IMPORTANT: If you have no intention of moving abroad in the future or not for a prolonged period of time then a QROPS transfer could be deemed as an aggressive tax avoidance measure and penalised accordingly.
Before making any decision to proceed with a QROPS transfer to avoid the lifetime allowance charge you should take time to consider your circumstances in full. There may be reasons for not moving your pension at this point in time. For example, should you be due to become a non-UK resident in the near future it may be worthwhile waiting until you are abroad, though you should still look into the matter beforehand to establish all the facts. Another reason may be down to your existing pension arrangements. If your company currently contributes it is important to understand what would occur if you moved your pension, what benefits would be given up both now and in the future, and what alternative options may be available. In these circumstances it may be in your interests to move any old or private pensions now and leave transferring your existing company pension until a later date. To show how this may benefit you consider the following;
To establish whether it is possible to avoid or reduce the lifetime allowance charge please feel free to contact us and we will endeavour to help you establish the facts for your personal circumstances.
Pension Transfer Help Line: +41 (0) 22 341 3421
Email for Assistance: firstname.lastname@example.org