In a few weeks something that sounds incredibly boring is going to happen. The government will change the lifetime allowance on individual pension pots. At the moment you can put up to £1.5m into your pension free of income tax (if not national insurance).
But from April, that falls to £1.25m. End up with any more than that – either from making contributions, having a good final-salary pension, or from making good investment returns – and you will be charged a flat tax of 55% on the excess.
You might think that these figures make no odds to you: there is, says John Fox of pension consultancy Liberty in The Mail on Sunday, a “widespread perception among pension savers that it is a wealth tax that will never affect them”. But that may well not be the case – particularly for those with defined-benefit pensions.
The value of a final-salary pension is considered to be 20 times the annual pension for these purposes. This means that anyone who, on retirement, has a pension entitlement of more than £62,500 before taking the maximum cash lump sum (or £46,875 after taking it) is affected.
To anyone not in a defined-benefit scheme, that seems a massive pension, but it would cover the majority of people on final-salary pensions who work for 35 years and finish on a salary of £85,000-plus. And over time it could cover more than that. Why? Fiscal drag.
It would be nice to think that the limit will rise with inflation over the years. But given the effort that has just been put in to slashing it, that seems unlikely. That suggests that it will fall every year in real (after-inflation) terms.
This is likely to end up being an issue for those in defined-benefit schemes, but also for those saving into a defined-contribution pension.
Let’s say you have £500,000 in your self-invested personal pension (Sipp) today. You are 45 and plan to retire at 65. If you put in no more money at all, but make annual returns of 5%, then by retirement you will have £1.32m. Make that 7% and you’ll have £1.93m. And if the lifetime limit doesn’t rise, you’ll end up paying an awful lot of tax.
The good news is that there is something you can do – apply for ‘fixed protection’, which will lock the £1.5m allowance in for your fund. There are downsides to this – you can’t put any more money in once you have fixed and those in defined-benefits schemes may find they lose out on some benefits by effectively becoming deferred, rather than active, members of their fund.
I don’t often suggest you take financial advice. But if you are coming up to retirement with a good pension to look forward to, now would be a good time to get some. Boring, but very important.