Talk of the ticking pension time bomb is all very familiar. While nobody denies it will be one of the major economic issues of this century, there are problems at the other end of the wealth scale, too.
Current pension legislation, specifically the lifetime allowance of £1.25m, is having a massive – and yet massively unpublicised – impact on bigger pension pots.
Essentially, people who are doing what the government wants them to do, namely save and save well, are being penalised in spectacular fashion. These aren’t ultra-high net worth individuals, either.
We recently crunched some numbers to show exactly how hard many savers will be hit.
Our calculations show that many people in their 30s and 40s with decent, if not huge, pension pots are likely to exceed the lifetime allowance without even making any further contributions, thereby triggering a tax charge.
In many cases this tax charge will be in the hundreds of thousands of pounds.
For example, a person aged 40 with a pension pot of £500,000 yielding 5 per cent per annum and retiring at 65 would see their end fund value – even without any further contributions – exceed the current lifetime allowance by £437,000. This would result in a tax charge of £240,350.
If the same person were to contribute an illustrative £3,000 per annum gross, with the same 5 per cent yield and again retire at 65, the total pension pot would be £1,833,000, a sum of £583,000 more than the current lifetime allowance, resulting in a tax charge of £320,650.
Hardly small change.
Our calculations also revealed that a 30-year-old with a pension of £250,000 would exceed the lifetime allowance by £118,000 without making any extra contributions. This would generate a tax charge of nearly £65,000.
Again, this size of pension pot is way above the average but is not uncommon among higher earners.
The only conclusion we can draw from this is that, for many high earners who save regularly to build up their retirement pots, it’s a case of damned if you do, damned if you don’t.
With the pension time bomb ticking, the government is desperate for people to save but then slap a huge tax charge on them the moment their pot reaches £1.25m.
A pot of £500,000 at age 40 or 45 is of course a very decent amount, but I wonder how many people in that kind of position know that they’re likely to exceed the lifetime allowance without even contributing another penny?
People need to understand the consequences of exceeding the lifetime allowance and the impact it could have on their pension pot and broader retirement.
You don’t need to be a multi-millionaire to fall foul of the rules and be hit with a potentially significant tax bill.
Given that, in some cases, there are ways to potentially protect clients against the tax bill – for example, ‘fixed protection 2014’ – never has the need for independent advice among higher earners been more important.
John Fox is managing director of Liberty Sipp
