Pensions just got significantly more flexible. In the recent Budget, the Chancellor, George Osborne announced wide-ranging reforms on how retirees can access the money saved in their pension fund.
Until now, there were limits on the amount of income that could be taken from a pension pot each year, forcing most people to buy an annuity at the age of 75 to act as a smoothing out of annual income.
Now even those with just small pension pots are free to spend their money as they wish once they are within 10 years of the state retirement age - without incurring any additional taxes.
This flexibility might make pensions look far more attractive, but it’s important to note that the Government has limited how much people can put into these tax-efficient savings plans.
This process has been underway for the past couple of years, with a number of reductions made to both the lifetime and annual limit for pensions.
From April 6 this new lifetime limit will be reduced from £1.5m to £1.25m. (Previously it was as much as £1.8m). At the same time the amount of money you can invest in a pension each year, is being cut from £50,000 to £40,000.
It is easy to assume that these changes will only affect the UK’s highest earners, but this isn’t necessarily the case. Thanks to the complex way in which the value of “final salary” pensions are calculated, many of those on more modest earnings could also be affected and those who breach these limits face hefty tax bills.
Below we outline the changes, and explain what savers can do if they want to protect larger pension pots. But savers should note that they need to act quickly if they want to put this protection in place.
Will I be affected?
According to HM Revenue & Customs’ own figures, this change to the lifetime pension limit will directly affect 360,000 savers - but over time it could affect many more.
Most people with personal pension or company pension schemes now have 'defined contribution' pensions. Here the pension you get depends on how much money you invest in a fund, and how these investments grow. At retirement this pot of money is yours, to either spend, or to buy an annuity, which pays a guaranteed income for life.
Here it is relatively easy to see whether you breach the lifetime limits, as your annual statement will show the total value of your fund. If the fund is already over the £1.25m limit you need to consider your options (see below).
Of course those who are near to this limit now, and may have several years to go before retirement, may be worried that future growth could push it over this limit. Those in this position may want to consider stopping contributions and saving in other investment vehicles instead (such as ISAs).
The picture is slightly more complicated for those with final-salary schemes.
Previously people were able to retire on a pension of £75,000 a year, before this lifetime limit became a problem. But from April 6 this year, the maximum pension that can be taken (after the lump sum) is just £56,250.
Clearly this is still a generous pension benefit, but this new lifetime limit will hit those in many middle-management and senior positions - particularly in the public sector where these pension schemes are still commonplace.
There is the danger that those who receive pay rises can find this pushes their pension benefits over the limit. This then can trigger a tax charge - which in some cases may negate the rise in their take-home pay. Those in this position should talk to their employer, and pension manager.
What can I do?
Savers will pay tax on any excess savings above the lifetime allowance limit.
There are two ways you can avoidpaying the lifetime allowance charge. The most common is to apply for “fixed protection”, which effectively caps your lifetime allowance at £1.5m. But to do this savers need to move fast, and apply to HMRC for this protection by April 6. This can be done online, or by post.
Applying for this protection will benefit those near to retirement who want to maximise the value of their pot – as well as savers who expect the value of their pension to grow without making any new contributions.
But it’s important to remember once this protection is secured, savers can’t contribute any more into their pension pots. Effectively they are “frozen”’ at the higher rate.
Those in final salary or defined-benefit schemes who take this option will see their pension rise only in line with inflation from this date, meaning that if they get a significant promotion or pay rise, this won’t be reflected in their pension benefits.
The other option is to apply for “individual protection”. This allows people to make further contributions into their pension, but a tax charge will still apply on any excess pension. However, this option could prove useful to those in company schemes who want to maximise their employers’ contribution - and aren’t offered any alternative benefit if they opt out or stop contributing to their company pension scheme.
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