Retirement savings have for many years been subject to limits, so the Government can manage the cost of pension tax relief. More and more people are seeing these limits impact their retirement planning.
A review of the allowances
In 2006, the Lifetime Allowance was introduced by the Government as a cap on the total value of your lifetime pension savings. Initially set at £1.5 million, the allowance has since been reduced to £1.055 million in 2019/20. The current plans are that the Lifetime Allowance will increase each year by Consumer Prices Index (CPI).
The Annual Allowance was also introduced at the same time and sets an annual limit on pension savings of £40,000.
Your Annual Allowance can be reduced further, for example to £4,000, if you are already taking flexible income from a pension (drawdown).
You may also have a reduced Annual Allowance if your income is over £110,000, and when your total income exceeds £150,000 including employer pension contributions. In these circumstances your Annual Allowance will be reduced at the rate of £1 for every £2 over the £150,000 limit, to a minimum Annual Allowance of £10,000.
Looking for alternatives
Helping clients to manage any potential tax charges for exceeding allowances is now a key part of retirement planning.
The tax charge is 55% on funds in excess of the Lifetime Allowance that are drawn as a lump sum, or 25% if left in your pension to provide taxable income.
If your pension savings in any year exceed the Annual Allowance you may be able to avoid an annual allowance tax charge by carrying forward any unused Annual Allowances from the three previous tax years. If you have no other unused allowance and have exceeded the Annual Allowance, the excess amount will be added to your income for the tax year and you will pay tax at your marginal Income Tax rate.
There are alternative tax efficient investments available in addition to your pension savings, including:
• Individual Savings Accounts (ISA) – Each UK individual has a £20,000 annual ISA allowance which grows free of Income Tax and Capital Gains Tax
• Venture Capital Trusts (VCT) which have an annual allowance of £200,000 and offer 30% tax relief on investments. They are free of Capital Gains Tax provided that the investment is held for three years
• Enterprise Investment Schemes (EIS) which have an annual allowance of £1,000,000 and offer 30% tax relief on investments. They are free of Capital Gains Tax provided that the investment is held for five years.
Both VCT and EIS investments can be higher risk as they invest in smaller businesses and new start-up ventures and can be harder to sell when you need the funds, as they are not as freely bought and sold as other investments. These investments will not be suitable for everyone because of their risks and should only ever represent a small part of your overall portfolio.
Risks can be managed further by investing in a wider spread of asset classes through collective investment schemes such as Open Ended Investment Companies or Unit Trusts. These investments are treated differently to pensions or ISAs for tax purposes, but can still be managed tax efficiently by utilising your annual Capital Gains Tax allowance (£12,000 in tax year 2019/20) and you annual dividend allowance (£2,000 in tax year 2019/20).
Making the right investment choices
Building a portfolio with pension, ISA and other investments helps to spread risk by diversifying your wealth across different asset classes and types of investments. Your Origen adviser can review your attitude to risk to ensure that your investments are suitable for you.
The level of investment risk you are willing to take will depend on many factors and our adviser will discuss this with you in detail to ensure you make the right decisions based on your financial goals and objectives.
By building a diversified portfolio, when you need to take income, you are in a good position to make use of the tax allowances available to you which are highlighted in our article ‘How to generate income tax efficiently’.
Ask your Origen adviser for their recommendation if you are concerned that your pension savings might be affected by the Lifetime Allowance or Annual Allowance. It is important to recognise that saving into a pension remains very tax efficient with tax relief on contributions, so these additional options should be considered alongside your pension savings.