How the Lifetime Allowance affects your clients and why financial planning can help
Posted onIn his 2021 spring Budget, chancellor Rishi Sunak announced that he was freezing the Lifetime Allowance (LTA) at £1,073,100 until 2026. This was a surprising move, as it had typically risen in line with inflation prior to this.
According to data published in Money Marketing, the allowance freeze could cost Brits more than £1.5 billion in lost pension wealth by 2025. In a time of economic uncertainty, when many people are concerned about their long-term plans, this could pose a problem.
If you have clients who are approaching retirement, exceeding the LTA could land them with a hefty tax bill when the time comes to draw their pension wealth. With that in mind, read on to find out what the allowance is and how working with a financial planner can help them to minimise its impact.
Your clients can benefit from tax relief when they make pension contributions
To encourage people to put money aside for their retirement, the government offers tax relief as a way to top up any contribution your clients make to their pension. This can be a valuable way for them to build their long-term wealth.
As we discussed in a previous article, the amount of relief your clients can claim depends on the amount of tax they pay. For example, if they’re a basic-rate taxpayer, they could receive an extra 20% relief on their contributions, while higher-rate taxpayers could receive 40% and additional-rate taxpayers can benefit from relief at 45%.
Because of this valuable benefit, there is a limit to how much your clients can contribute to their pensions in a given tax year. In the 2022/23 tax year, this Annual Allowance stands at £40,000 or 100% of their earnings, whichever is lower.
Very high earners, and working clients already drawing a flexible income, may have a lower Annual Allowance.
In addition to limiting how much your clients can contribute each year, there is also a cap on how much they can put into their pensions over the course of their working life in a tax-efficient way, known as the LTA.
To put it simply, this is the amount that your clients can withdraw from their pensions before they trigger a tax charge. This fee is 55% on any excess funds taken as a lump sum, or 25% if they choose to take it as income.
Rising inflation could make it more likely that your clients exceed the LTA
In recent months, there has been a spike in the cost of living in the UK. According to data from the Office for National Statistics (ONS), the Consumer Price Index (CPI) reached 7% in the year to March 2022.
This can pose a problem as, while the LTA remains frozen at its current level, your clients’ earnings – and so their pension contributions – may continue to rise.
Due to this, it could be much more likely that your clients will be affected by the threshold in the coming years. This is especially true when you consider that the total value of their fund will also include tax relief and investment returns.
If your clients trigger the LTA charge, the additional tax could mean that their pension doesn’t go as far as they expected.
This can be a problem, as it means they may not have enough wealth to sustainably enjoy the lifestyle they want in retirement. At a time when they should be relaxing and enjoying the rewards of their hard work, worries about money are the last thing they need.
Working with a planner can help your clients to minimise the impact of any tax charges
If you have clients who are approaching the LTA, they may be tempted to halt their contributions to avoid going over the threshold. Of course, while this would reduce the likelihood of triggering the charge, it’s important to bear in mind that this isn’t always the right decision for their needs.
Instead, if they want to minimise the impact that the tax could have on their pension wealth, seeking professional advice can really help. For example, a planner may recommend that your clients:
Reduce their pension contributions
One option is for them to reduce their contributions and divert some of their wealth to other savings and investment options, such as an Individual Savings Account (ISA). This is a tax-efficient way to build their wealth, as returns are paid free from Capital Gains Tax and Income Tax.
Withdraw excess pension as income
A planner may also recommend that your clients draw their excess pension as an income, rather than a lump sum. This can help to reduce the amount of tax that they would have to pay when making withdrawals.
Apply for Lifetime Allowance protection (where applicable)
If your clients are eligible, another option is to seek Lifetime Allowance protection. This could potentially raise their LTA up to £1.25 million, but they may not be able to make any further contributions to their pension.
Working with a financial planner can help your clients to put a plan in place to minimise their tax liability. This can give them peace of mind to know that they have enough wealth to enjoy the retirement they want when the time comes.
Get in touch
If you have clients who could be at risk of breaching the LTA and want to minimise the effect that it could have on their long-term plans, we can help. Email enquiries@blackswanfp.co.uk or contact your adviser on 020 3828 8100.
Please note
A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits. The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation and regulation, which are subject to change in the future.
This article is for information only. Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.