7 March 2014 | Taxation
Doctors, senior professionals and even headteachers saving into final salary pensions are in the danger zone for hefty tax charges when the Lifetime Allowance (LTA) falls in April.
From April 6, the amount of savings that can be built or accrued in both defined contribution or defined benefit schemes, and receive tax relief, will fall from £1.5m to £1.25m. Savings accrued above the new LTA face tax charges of up to 55 per cent.
The Lifetime Allowance covers the total benefits in any pensions. For defined contribution or “money purchase” schemes, it is simply a matter of determining whether your fund is likely to be valued more than £1.25m by the time you draw benefits. To calculate this, you need to take into account the expected fund growth and future level of pension contributions.
Working out the value of your defined benefits is slightly more complex and entails ascribing a capital value to future benefits. You will to ascertain your expected annual pension and any tax-free lump sum before you can work out this value.
Once you have an estimate of your annual pension, multiply this income by 20 (not 16, the factor used for annual allowance calculations) and add on any additional tax-free cash due.
Experts say that in general, you are likely to be affected if you are on track for a final salary pension, with no separate lump sum, of more than £75,000 a year, or, a salary-related pension over £56,250 plus the maximum tax-free cash lump sum.
HM Revenue & Customs has a Lifetime Allowance checker tool, which can be found at hmrc.gov.uk
Those earning more than £100,000 and paying into a scheme pension for decades, rather than years, are more likely to be exposed to a potential tax charge, say pension experts.
“If someone had 40 years in a normal DB scheme the maximum (pensionable) salary that individual could earn before hitting the cap would be £93,750 a year,” said Andrew Tully, pensions technical director with MGM Advantage.
“If they had 30 years in a DB scheme then their salary would need to be above £125,000 before they breached the limit.”
You need to combine the values. If they are a mixture of final salary schemes – perhaps from a previous employment – and defined contribution plans, you need to calculate the capital value of the final salary benefits (including any tax-free cash) and add them to the expected defined contribution plan value.
The government has put in place arrangements for individuals to apply for protection against a potential lifetime allowance charge. These new protections offer advantages particularly for final salary workers in the public service.
There are two types of protection available when the Lifetime Allowance is reduced including Fixed Protection 2014 (FP2014) and Individual Protection 2014 (IP2014). You can apply for one or both types.
Fixed protection 2014 Is available whether the value of your pension benefits on April 5 is under or over the new lower limit £1.25m. This protection sets your allowance at the current limit £1.5m. However a condition of this protection is that pension saving stops and you opt out of a final salary plan. The deadline for applying for this protection is April 5. You can apply for this protection online hmrc.gov.uk
Individual protection 2014 is only available if the value of your pension benefits at April 5 exceeds £1.25m. Your protection will be set at the value of your benefits on April 5, up to a maximum of £1.5m. A key difference between this protection and FP2014 is that your can carry on contributing without losing your protection. However, any excess over a personalised lifetime allowance will be subject to the lifetime allowance charge.
IP14 may be particularly attractive in cases where individuals would not be able to receive higher pay in lieu of pension if they opted out of the scheme. If there isn’t a fair cash alternative from an employer it is likely to be more valuable for them to remain in the scheme even if some of their savings will be taxed.