Pension Bear Traps?

Covid has changed much about our lives and it appears from the latest statistics to have reversed the long term trend of people working longer.  Which makes us all more dependent on our pensions.

Pensions are fantastic tax efficient structures for long term saving.  But there are a few pitfalls that need to be avoided.

Recent statistics from the Office of National Statistics^[1] showed fewer over 50’s in work, reversing a longer term trend of increased activity in later life.  Whether through choice or necessity, the Covid pandemic is altering lives.

The big question is always ‘can I afford to stop work’?  And at that point, you have to talk Pensions – the one subject that few people want to discuss and where eyes very quickly glaze over!

The facts remain that after numerous changes to the structure and rules governing pensions, it is the only saving vehicle which gives you tax relief on the way in, largely tax free growth, and some tax relief on the way out.  Even if you kept your pension fund in cash, it would make sense to save the maximum you can afford.

But there are a few bear traps that it is important to watch out for.  Get caught in one of these and the tax consequences can start to erode the benefits.

Trap 1: There is a maximum limit on the size of your pension pot known as the Lifetime Allowance and set at just over £1million.

The Lifetime Allowance is the maximum size of a pension pot – anything over this at the point you come to retire will trigger a 55% tax charge.

The Chancellor has reduced the Lifetime Allowance in recent years and in 2016 set it at £1million.  It increased by the rate of inflation rate, but it is no longer inflation linked so will remain at the level of £1,073,100 at least for the rest of this parliament.    

Retirement may seem a long way off but a pension pot of £650k today will potentially trigger a tax charge in 10 years time even if you made no more contributions and assuming 5% per annum growth – the long term real return from equities. 

Trap 2: If you earn in excess of £240,000 including pension contributions your employer makes, the income tax relief you can claim (known as the annual allowance) tapers down to as low as £4,000.

This means that for every £2 of income you have over £240,000, your annual allowance is reduced by £1. The maximum reduction is £36,000. So anyone with an income of £312,000 or more has an annual allowance of £4,000.

Amounts contributed in excess of £4,000 will be subject to an annual allowance tax charge of up to 45%. Most large employers cap benefits and offer a cash alternative but it’s always good to check that there is not a rogue direct debit somewhere that is still contributing and particularly if you are fortunate enough to be in a final salary scheme such as for public sector workers.

Trap 3: Check the details on any death in service policies you have as this could cause you to breach your Lifetime Allowance triggering a pension charge

Some death in service schemes are written alongside a corporate pension and if they are not correctly structured could end up triggering a tax liability on your pension.

As clients of Cavendish Ware, your adviser will be keeping this all under review.  But if there is anything you think we’ve missed or you haven’t told us about then please do get in touch.  And if you happen to be discussing pensions with a friend then make sure they are alert to potential traps.

^[1] Office of National Statistics, Living longer: older workers during the coronavirus (COVID-19) pandemic and Employment in the UK February 2022