Lifetime allowance. Avoid a potential 55% tax penalty. Act now.

If you are building up a generous company pension scheme, imminent changes to the taxation of pension savings could seriously cost you, unless you act quickly.

April 05 is the deadline to secure protection against heavy tax charges on your pension pot. This is due to the reduction in the ‘lifetime allowance’ - the maximum anyone is allowed to have in their pension funds (apart from the state pension) without facing extra tax charges. This used to be set at £1.8 million, but was reduced first to £1.5 million in 2012-13 and now to £1.25 million this April. After that date, any excess will be subject to tax at up to 55%.

The £1.25m figure may sound high but many thousands of people will be impacted – especially those in final-salary schemes who have built their entitlement through many years’ work. According to HMRC, the 2014 reduction to £1.25m will mean that 360,000 pension savers are affected.

So don’t assume that this won’t apply to you. For example, ‘final salary’ benefits are generally regarded as worth 20 times the annual pension for the purposes of calculating the lifetime allowance. So anyone with a pension entitlement of over £62,500 will be affected and the excess taxed at up to 55%

In addition, anyone who is around ten years from retirement could easily exceed the lifetime allowance if their current accrued pension is over £38,000. This could be due to future promotions, salary increases, or even the statutory revaluation of preserved pensions.  

So middle managers on five-figure salaries could easily be affected if they are long-standing members of final-salary schemes. Doctors who belong to the NHS final-salary scheme, for example, could be affected.

Of course, if you are in a defined contribution scheme,then it is easier to see whether the cap will be breached. However, in all cases, it is important to take into account the monies you have in legacy pension schemes from previous employers or plans. If you are not sure, check with your tax adviser or financial adviser.

There are ways in which you can avoid paying the lifetime allowance charge, starting with applying for “fixed protection”. This allows you to keep the previous lifetime allowance of £1.5m without incurring a tax charge, but only if no further pension contributions are made after 05 April 2014. You can do this by applying to HMRC before the 06 April deadline, either online via the HMRC website or by post.

If contributions are made after that date, you will lose the fixed protection and your pensions will be subject to the new £1.25 million lifetime allowance. This means you could be liable to the 55% tax charge on any excess.

There are also two further options for you to consider. Firstly, you could bring forward your contributions, using the carry forward rules, making them before 05 April 2014 and then applying for fixed protection.

Secondly, if your pensions are worth more than £1.25m on 5 April 2014, you can apply for ‘individual protection’. This gives you a personal lifetime allowance based on the value of your pensions at 05 April 2014, up to £1.5 million.

Unlike with fixed protection, you will still be able to make contributions to your current and/or new UK pension schemes, and, perhaps more importantly, continue to enjoy employer pension funding. But if your fund does exceed £1.5 million in future, the tax charge will then apply.

Individual protection is therefore likely to be more appropriate for younger people who want to be able to make more contributions to pension plans in the future.

So if you are affected, there is much to consider in a relatively short space of time. 

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