The huge price being paid by prudent pension investors for “saving too much” has been laid bare by the Government’s own tax statistics, obtained by Telegraph Money via a freedom of information request.
HMRC’s figures show that the total amount of tax paid by people whose pension savings rise above the lifetime limit has jumped by 33pc in 12 months to £120m.
While comparatively small numbers of investors are paying this penal tax so far, their numbers are growing. The average tax bill for those affected is an astonishing £46,332.
Gradual cuts to the amount you can save into a pension over your lifetime, now £1m and down from £1.8m at its peak, have come at the same time as stock markets surged. In the 2016-17 tax year alone, 2,590 people had to pay tax because their savings broke through the £1m limit.
Since 2010, 8,260 have had to pay the lifetime allowance tax to the tune of £390m (see chart, below). “The lifetime allowance charge is an anomaly,” said Alistair Cunningham of Wingate Financial Planning, the advice firm.
“Not only are pension contributions restricted on an annual basis but the total value is ‘tested’, often more than once, against this £1m lifetime limit. The lifetime allowance test is more than just a tax for those who save too much – it also penalises investment growth.”
Pension savings above the £1m threshold are subject to either a 55pc charge, if taken as a lump sum, or 25pc if taken as income. In the latter case, the tax applies in addition to regular income tax. Anyone with a £1m-plus pension pot is likely to pay the higher rate of 40pc.
As income tax is deducted after the lifetime allowance charge, you end up paying roughly the same amount of tax either way. The tax charge is high because it is an attempt to claw back the tax relief that all pension contributions attract.
The Government forgoes billions of pounds in tax a year as a result and since 2011-12 has been cutting the lifetime limit to save money. Because tax relief is based on savers’ income tax bracket, it is argued that higher earners benefit the most.
What makes the tax rules more tricky to navigate is that all types of pension count towards the limit. That means future entitlement to “final salary” pensions, which were the dominant form of pension savings up to the Nineties, must be addedtomorerecent “defined contribution”-typepots.
To do this you need to multiply the expected annual income from the final salary scheme by a factor of 20. For instance, if you had a £300,000 defined contribution pot and a final salary pension forecast to pay £10,000 a year, your total pension savings would be worth £500,000.
Successive cuts
Experts are united in their criticism of the system. While many agree that the amount of tax relief given to high earners should be curbed, they say having both a lifetime allowance and an annual allowance serves only to put people off saving.
The annual allowance is normally £40,000 but since April 2016 has been reduced for those who earn £150,000 or more on a sliding scale to a minimum of £10,000 a year.
Anyone who makes use of the options introduced by the “pension freedom” reforms has an even lower annual capof £4,000.
“The lifetime allowance has been ‘salami sliced’ in successive cuts to the point where it isn’t just an attack on savings incentives for the ultra-rich,” said Tom Selby of AJ Bell, thefund shop.
“While £1m might sound like a lot of money, for a 65-year-old couple it buys a ‘joint-life’ inflation-linkedannuity worth around £21,000 a year.A healthy income but not one you’d associate with being a millionaire. At this level, the lifetime allowance feels like an extremely low bar to set if the aim is to turn Britain into a nation of strivers and savers.”
Mr Selby added that if the lifetime allowance had been allowed to rise with inflation, instead of being cut since 2011, it would now be £2m.
Employers forced to offer cash instead of pensions
As the pensions allowances have dropped, businesses are being forced to offer staff alternatives.
At Nats, the air traffic control agency, staff who reach 85pc or more of their lifetime allowance are being offered a 25pc salary boost in place of pension contributions. In some cases this has led to staff in their 30s being offered cash instead of further pensionsavings.
Claire Trott, a pensions specialist at Technical Connection, warned that giving up “active membership” of a final salary plan, as in the Nats case, could also mean that other valuable benefits such as “death in service” payments are lost.
She said: “Offers like this need to be carefully assessed to establish what is the best option for each individual member, irrespective of how tempting a salary increase now may be.”
As Telegraph Money has previously disclosed, the complexities around the annual allowance for high earners have forced one in three British firms to cap pension contributions at £10,000 a year.
Related Topics
- Retirement,
- Income tax,
- Your money, your family,
- Tax in retirement
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