Act fast to protect your pension from a three-pronged legislatory attack.
Three new pension rules are coming into effect in April 2014. Plan for them now to safeguard your retirement.
Pensions is a fast-moving marketplace, considering these are plans that you are likely to save into for 30 years or more before you retire. This year is notable because of three main changes that anyone with a pension needs to consider in union to prevent unwanted tax bills in later years.
The three new aspects that will affect your pension in the coming years if you do not act now are:
The change in the lifetime allowance from April.
The reduction in the annual allowance from April.
The impact of auto-enrolment on executive pensions.
Any one of these on its own could be sufficient to derail your pension plans, but thanks to their inherent interaction, you cannot deal with any in isolation without running the risk of a triple whammy at retirement.
1. The lifetime allowance is falling
The lifetime allowance – the amount you are allowed to have in a pension without incurring a hefty tax charge from HM Revenue & Customs – is going to be reduced from £1.5m to £1.25m in April. Unless you take action to prevent your pension falling foul of the new rules, you could face a shocking amount heading to the taxman when you come to retire.
Anyone exceeding the lifetime allowance when they retire – and remember, this not only includes payments made into your pension and tax relief, it also includes investment growth – will face a tax charge of 55% on anything above the limit. So this would mean someone having over £1.25m in their fund after April 6 could face a tax bill of £137,500.
If you plan ahead, you will be able to protect your pension from this fall in the allowance, but time is running out so you need to speak to your adviser as soon as possible. It is not sensible to try to deal with this alone, as the lifetime allowance covers all of your pension savings, no matter how many separate pots you have or what format they are in.
Executives are likely to have generated substantial pension pots at a variety of companies they have worked with, and not checking how much each is worth could potentially leave them open to this tax charge if they breach the limit. Given that nearly two thirds of pension holders do not know the value of their combined pension savings and that one in four men have more than three pension pots this could be a relatively large problem among higher earners.
An additional difficulty is added if you consider that the state retirement age will rise to 68 by the mid-2030s, meaning there is more time for the funds to grow beyond the £1.25m cap if they are not regularly checked. But you can prevent yourself from being in this position by taking action now.
2. You are also about to lose one fifth of the annual allowance
Not content with reducing the amount you can have in your pension pots in total, the Government is also reducing the amount you can put into a pension and still receive tax relief on from £50,000 to £40,000 a year from April.
This is expected to hit around 140,000 people and the limit has been severely eroded from £255,000 in 2011. If you are regularly using the full allowance, you will have to consider alternative means to deal with your pension planning, which could include putting additional money into your spouse’s pension to secure your joint standard of living when you retire.
These additional payments to other pensions are not limited to £3,600 despite a widespread misunderstanding of the rules and a good adviser can help you maximise your wealth distribution, whether it is into a relative’s pension pot, or alternatively to another type of investment that would be more suited to your needs.
Of course, you also need to ensure that you are claiming all of the tax relief available to you from your pension payments, as you may need to claim the higher rate tax relief on a self-assessment form from HMRC.
3. Auto-enrolment could hit your pension protection
As if that was not enough, you may also fall foul of the new auto-enrolment rules which are designed to help employees. While auto-enrollment is widely considered to be a good thing for the majority of people because it encourages pension saving where previously there may not have been any, as an executive it could potentially harm your pension planning.
The reason is that auto-enrolment is a statutory requirement for all companies employing staff and will also be applied to executives of the company. If you have previously taken, or plan to take within the next month, enhanced or fixed protection of your life allowance then being in an auto-enrollment scheme has the unwelcome side-effect of removing any prior or current protections you have in place.
Unless you opt out of the scheme within the first month after you have been auto-enrolled, you will be considered as a member of the scheme by HM Revenue & Customs, and consequently lose the lifetime allowance protection you had put in place.
Without this protection, any amount you have built up in your pension pots over and above the £1.25m limit which comes into force in April, will face a 25% tax charge if you use the additional amount to generate a pension, or at 55% if you take the additional amount as a lump sum.
What you should do now
The way that these three rule changes intertwine mean you cannot simply plan to mitigate one of them without having a potential impact on another. So you should take advice as soon as you can to make the most of your pension planning for the coming years without having to be concerned about additional tax charges or a loss of income.
But time is of the essence and as the clock ticks closer to April 6, unless there is a reprieve in the Budget on March 19, you have a lot to do in an ever-smaller timeframe.
Discover how to use modeling to plan your pension and financial future: Retirement Planning Toolkit