Britons hit with 55% pension tax as allowance ‘more than halved’

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Budget 2021: Sunak announces pension lifetime allowance freeze

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In his past life as Chancellor, the new Prime Minister Rishi Sunak announced he would be freezing a range of allowances until the 2025/26 tax year. One of these was the Pension Lifetime Allowance, which limits the amount a person can save into their pension across their lifetime while still benefiting from tax relief.

If the Lifetime Allowance is exceeded, then Britons are likely to be subject to a 55 percent tax, which many will hope to avoid.

At present, the Lifetime Allowance stands at £1,073,100, which does appear to be a high amount.

However, the freeze alongside rising inflation has had a severe impact on pension savers.

Interactive investor highlighted inflation since 2006, when the cap was first introduced, means £1,500,000 – the original cap – would now be worth £2,322,583 in today’s money.

It means the Lifetime Allowance has more than halved in real terms for pension savers.

Alice Guy, personal finance expert, at interactive investor, said: “Freezing the Lifetime Allowance at £1,073,100 would make it more difficult for pension savers to achieve a comfortable retirement. 

“Inflation since 2006, when the cap was introduced, means that £1,500,000 (the lifetime allowance in 2006) would now be worth £2,322,583 in today’s money.

“A private pension pot of £1,073,100 would give someone a pension income of around £32,193 per year if they withdraw three percent per year from their pension. 

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“It’s a relatively modest amount and is only around the current average salary in the UK.”

Understandably, pension savers will not want to exceed this stringent limit.

Myron Jobson, senior personal finance analyst at ii, expressed concerns about what this could mean.

He added: “The worry is pension savers who have been kicked around like political football, will miss out on valuable tax relief by deciding not to save more into their pensions in fear that they might exceed the LTA limit.”

People should be aware LTA checks are carried out at certain times.

These checks are to determine whether the value of someone’s pension exceeds the Lifetime Allowance.

These checks typically occur:

  • When a person starts drawing their defined benefit pension
  • When a person takes an income or lump sum from a defined contribution pension
  • If a person transfers their pension overseas before age 75
  • If a person reaches their 75th birthday and has a pension in drawdown or that they have not touched
  • If a person dies before age 75 with pensions they have not touched.

After the age of 75, Britons usually have no further checks against the Lifetime Allowance. 

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To avoid being hit with tax, it is important for savers to monitor the value of their pensions.

The increase in value of defined benefit pensions in particular may be surprisingly large, the Government-backed service MoneyHelper has warned.

The service added: “You might also want to consider applying for protection if your pension savings are expected to exceed the lifetime allowance threshold.

“There were and are protections that can help you avoid a tax charge by giving you a higher lifetime allowance.

“You can check if you already have protection but you will need an account for HMRC online services. If you don’t have an account, you can create one.”

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