Exceeding your pension lifetime allowance (LTA) can be very costly, and for many it comes as a nasty surprise; but more and more people are facing a significant tax charge. Could complicated pension rules be tripping up individuals?
Pension rules have changed considerably since 6 April 2006 when the LTA was first introduced. Since then we have had numerous changes to both the LTA and the annual allowance, fixed protection and individual protection, not to mention a whole raft of new rules following the introduction of pension flexibility from 6 April 2015.
With such a lot going on it’s no surprise that individuals may be confused about or simply oblivious to a potential tax charge on their pension fund. Recent figures suggest that the amount of tax collected from such tax charges has increased more than tenfold since the introduction of the LTA in 2006.
Individuals usually pay tax if their pension pots are worth more than the LTA. This is currently £1.03m.
The rate of tax that is paid on pension savings above the LTA depends on how the money is paid to the individual – the rate is:
- 55 per cent for a lump sum; or
- 25 per cent for withdrawals taken as income, such as annulties or draw-down payments.
The tax is deducted by the pension provider before the pension is paid to an individual.
Many individuals may be sleepwalking into a charge on their pension fund due to exceeding the LTA for one of many reasons. This might include not regularly checking the value of your pension fund but continuing to make maximum contributions year on year, or forgetting about older pension funds, perhaps from previous employments.
A particularly nasty problem can be caused by auto-enrolment in an employer’s pension scheme. An employer must re-enrol all employees every three years, including those who have previously opted out. Some of those opting out may have done so because they were at or close to the LTA and had applied for one of the protections available at various times. Such protection is unfortunately lost where any further contributions are made to any scheme, resulting in a potential tax charge of up to 55 per cent on withdrawals from the previously protected element of the fund.
It’s important for individuals to monitor their pensions on a regular basis and to make sure they do not fall into any of the many traps which might lead to an unexpected tax charge.