It may seem like the ultimate first world problem.
However, saving too much into a pension could cost you tens of thousands of pounds in unnecessary tax.
We all need to prepare for retirement. In fact, according to the Government, 45% of us aren’t putting enough away (Source: The Pensions Advisory Service). However, those that are taking their retirement planning seriously are in danger of falling foul of an often-overlooked allowance, that limits the amount that can be paid into a pension.
As with most things in the financial world, knowledge is power. Awareness of limits, allowances, hurdles and hoops can ensure that all the hard work you are putting into your retirement planning isn’t going to waste.
So, what is this limit? And exactly how much do you stand to lose if you go over it?
Lifetime Allowance
Currently, the amount that you can hold in a pension before paying tax is £1 million.
It’s a relatively high figure, and one that many people won’t come close to reaching. However, high earners and young workers who have started saving for retirement at an early age may find themselves approaching it rapidly.
If you breach the lifetime allowance you will pay tax at a rate of:
- Taking a lump sum gets taxed 55%
- Withdrawing it another way gets taxed 25%
The amount of tax paid is increasing, with a 33% rise in the last 12 months to £120 million (Source: HMRC). This equates to an average tax bill of £46,332 for the 2,590 people affected.
Another limit on pension contributions comes in the form of the Annual Allowance. This, as the name suggests, is the amount you can contribute each year without paying tax, and is currently the higher of:
- 100% of your earnings
- £40,000
In past years, this limit has applied to everybody. However, since April 2016 it has been reduced on a sliding scale for anybody earning £110,000 or more per year.
How can you stay under the limit?
The answer to this is the same as any other preventable problem; planning.
If you are young, having a pension worth £1 million might seem like a distant dream, but even relatively modest contribution levels can see you reaching it. Likewise, if you older and making significant contributions, you may well get close to the allowance.
Working with a financial planner will help avoid any nasty surprises, and it might be sensible to consider other methods of planning for retirement.
This can be done by showing you other tax-efficient forms of saving. For example, if you are close to reaching your Lifetime Allowance, but you haven’t made the most of your ISA allowance, you may be better off saving using an ISA. These tax-free pots can ensure you don’t fall foul of any limits, which could have a huge impact on your financial future if you encounter a large tax bill.
Hindsight is 20/20 (or so they say). However, for the 2,590 people who breached the Lifetime Allowance in the 2016/17 tax year, proper planning could have potentially prevented the tens of thousands of pounds paid in tax.
To avoid becoming a member of this unfortunate group, and to ensure that your pension contributions stay under the Lifetime Allowance, get in touch using the phone number at the top of the page.