£40,235 each – that’s what Sunak’s ‘cruel’ 55% pension tax costs savers. Will YOU pay it?

Budget 2021: Sunak announces pension lifetime allowance freeze

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More than 1.6 million savers are on course to pay a punitive tax charge after exceeding the pensions lifetime allowance. This the maximum you can build up in workplace and personal pensions over your lifetime. Growing numbers are set to get caught and the cost is huge.

More than 8,500 savers exceeded the lifetime allowance in the 2019/20 tax year, incurring penalties totalling £342 million, HM Revenue & Customs figures show.

That works out as a punitive £40,235 each on average, which is a huge chunk of money for the Government to take out of people’s pensions for no good reason.

In the last decade, the number of people caught out has risen tenfold, as has the amount of tax paid. This will accelerate now that Sunak has frozen the lifetime allowance for five years.

Many people who thought their combined workplace and personal pension pots would be nowhere near the allowance may soon be in for a shock, warned Stephen Lowe, director at retirement advisers Just Group.

He slammed the pension rule as cruel and “needlessly pernickety” because it confuses and catches out so many for little purpose. “It is using a pile driver to crack a nut.”

Constant Government tinkering means that many people do not understand how the lifetime allowance works or whether it will affect them.

Here is a (very simplified) version of highly complex lifetime allowance rules, and how to plan for them.

What is it? The lifetime allowance is a limit on the overall amount you can save across your various pensions before extra tax charges apply.

Why are people so worried about it today? The lifetime allowance was set at £1.5 million in 2006. If it had risen with inflation, it would now be worth £2.2 million. Instead, it has been repeatedly cut back and now frozen at £1,073,000 until 2025/26. As stock markets and pension pots increase, more and more people will get caught out.

Does it only affect the super rich? While the rich are most likely to get hi, those who have saved diligently through their lifetime or belong to a defined benefit final salary pension are also vulnerable.

“A defined benefit pension that pays around £50,000 a year, which includes many long-serving public sector employees, may breach the limit,” Lowe said.

How is it charged? The 55 percent tax is only paid on the chunk of your pension that exceeds the lifetime allowance, rather than your entire pot. If you take your pension as a lump sum, you could pay 55 percent tax BEFORE you receive your money.

If you take it as income instead, you pay an immediate charge of 25 per cent. You would then pay income tax at your usual rate on the remaining 75 per cent of pension. For a 40 percent taxpayer, the tax bill would till total 55 percent, falling to 40 per cent for a basic rate taxpayer.

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How is it calculated? Calculations to determine if you have exceeded the allowance are carried out at various times. If your pension climbs above the lifetime allowance then later falls (after, say, a stock market crash) that could reduce the tax charge, Lowe said. There are further tests at age 75 and on death, to check if you have tax to pay.

Lowe urged savers to check their annual pension statements to see if they are likely to incur a charge. “If you are already close to breaching the allowance it may be worth putting future pension savings elsewhere, say, into an Isa.”

Think twice about doing this if you would lose employer pension contributions as a result.

If concerned or confused, seek independent financial advice. Or risk a shock later.

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