Rumours of Huge Pension Lifetime Allowance Increases

Whether it is a leak or simply a well sourced rumour, there is speculation across financial services media that the Chancellor of the Exchequer, Jeremy Hunt, will tomorrow unveil huge increases to the Pensions Lifetime allowance (LTA) and Pensions Annual Allowance (AA).

What is the Pension Lifetime Allowance?

Introduced in 2006, this is the maximum value or equivalent value your can accumulate in pension value during your lifetime.

Lifetime Allowance is calculated as follows:

• Money Purchase:  The fund value of investment linked/money purchase funds such as workplace pensions, stakeholder pensions, personal pensions, and self invested pensions at the time you crystalise the pension i.e., take any of the 25% tax-free lump sum and taxable income.  NB: If you take some or all of the tax-free lump sum only this is not considered a benefit crystallisation event.  When taking some of the taxable element it is the value of the whole pension fund that is included.
• Defined Benefit: Work pensions that pay a guaranteed income for life and tax-free lump sum.  This is where the pension has no direct fund value as it is a calculation to work out the equivalent value.  Defined benefit schemes can be final salary pensions, career average salary pension and other guaranteed pensions.  Usually, the value is worked out as a multiple of 20 times the value of the pension income when you take it plus the tax-free lump sum taken.  E.g., if you receive a pension of £10,000 pa plus a lump sum of £30,000, the lifetime allowance equivalent value is £10,000 X 16 = £160,000 + £30,000 = £190,000 for LTA purposes.

The Lifetime Allowance is currently at £1,073,100.  If you exceed this allowance, you face tax penalties.  Speculation is that this will be increased in the Budget tomorrow to £1,800,000, which is only back to where it was in 2010 through to 2012.

What is the Pension Annual Allowance?

This is the maximum value or equivalent value that can be contributed by both you and your employer to your pension schemes each tax year – this is a combined amount into all pensions.

Annual Allowance is calculated as follows:

• Money Purchase:  The physical gross (including tax relief) amount paid into your investment linked/money purchase funds such as workplace pensions, stakeholder pensions, personal pensions, and self invested pensions in a tax year.
• Defined Benefit: Work pensions that pay a guaranteed income for life and tax-free lump sum.  Both you and employer pay into your pension to secure the guaranteed pension, but the annual allowance value is not what is physically paid in as pension contributions but is a value worked out as a multiple of 16 times the value of the projected pension income benefit increase that year plus the difference in the projected tax-free lump sum.  E.g., Last year your pension entitlement was £10,000 pa plus tax free lump sum of £30,000.  This year your entitlement is £11,000 pa plus £32,500 tax free lump sum.  This is a difference of £1,000 pa (x 16) = £16,000 plus tax free lump entitlement difference £2,500 = £18,500 of your annual allowance was used in that tax year.

The Annual allowance is currently the lower of your salary or £40,000 pa.  If you exceed this allowance, you face tax penalties.  If you earn £20,000 pa, the maximum that can be paid into your pension is the lower of your salary or £40,000 pa i.e., £20,000 pa.  If you earn £60,000 pa, the maximum that can be paid into your pension is the lower of your salary or £40,000 pa i.e., £40,000.  Speculation is that this will be increased in the Budget tomorrow to £60,000 pa.  This was at £255,000 pa in 2011 and was reduced to £50,000 pa in 2012 and reduced again to £40,000 pa in 2014.

Comment

Despite headlines suggesting this is a move to encourage people back to work, we suggest it is not a ‘headline’ that will encourage ‘50 somethings’ back to work, it is more so an encouragement for senior health care professionals, civil servants, emergency services and local government workers that are near the lifetime allowance threshold and/or the annual allowance limit to not take early retirement as they would get penalised if they stay on at work and build up even greater pension benefits only to then be heavily taxed on them.  Increasing the allowance thresholds would clearly remove some pressure on those that may be thinking of leaving early due to excess over allowance penalties.

That said, it would be most welcome and will present easier retirement planning options for all.