At the Budget on 3rd March, the Chancellor announced that the Pension Lifetime Allowance (LTA), which is the total amount that your pension fund can grow to before you have to pay a penalty tax of 25% on any excess, would be frozen at £1,073,100 until April 2026. Previously, the Lifetime Allowance had been scheduled to increase in line with CPI inflation every year.
We have received numerous questions from clients about the impact of the Lifetime Allowance freeze and in this article, we share these with you.
- If your employer contributes to your pension, should you continue to accept the employer contributions (and make your matching contributions) even if you breach the LTA?
- Will you be better off taking up an employer’s offer of extra salary in exchange for pension contributions?
- Should you stop paying into your pension if it leads to a tax charge on savings in excess of the LTA?
Loss of employer funding
Employer pension contributions are essentially ‘free money’. Even if you suffer an LTA charge of 25% you are still better off because you are receiving 75% of something you would otherwise miss out on. Depending on how generous the employer matching contribution is, it is likely to be sensible to continue to contribute despite the fact that this will mean that 25% of your contributions will be lost.
Alternative employer remuneration package
Some employers are prepared to offer additional salary instead of making pension contributions. However, the salary offer, net of tax, may not be as beneficial as receiving the money into the pension (despite the 25% LTA charge) even factoring in the tax you would expect to pay on withdrawals in retirement. If you are an additional or higher rate taxpayer, and you expect to be able to draw money out of your pension at 20% tax in retirement, then you are likely to be better off receiving the employer pension contribution than the salary offer.
It is important to remember that (as the legislation currently stands) pension funds do not suffer inheritance tax. For those who expect to have a large estate on death, being able to shelter as much money as possible in a pension fund from inheritance tax is a real benefit. Better to pay a 25% tax charge on any amount in excess of the LTA than 40% inheritance tax.
It’s only natural to want to limit tax charges of any kind, but it’s important to understand the knock-on implications as the headline tax charge of 25% may not actually prove to be that bad compared to the alternatives. If you would like to discuss the interaction between making pension contributions and the lifetime allowance charge, please get in touch with your usual RG contact.