If your clients have been proactive with their pension planning throughout their working lives, they might have set aside quite a large pot in preparation for their pending retirement.
Pension contributions are usually a tax-efficient form of saving, but there are instances where your clients can exceed their allowances and expose themselves to taxes.
There are two allowances that your clients will need to be aware of when saving for their pensions: the Annual Allowance and the Lifetime Allowance (LTA).
The LTA is currently capped at £1,073,100 for the 2022/23 tax year and will be frozen at this level until at least April 2026.
According to the latest figures from HMRC, the number of Britons breaching the LTA has increased by 21% from the 2018/19 tax year to the most recently analysed 2019/20 period.
This leaves many Britons who have saved efficiently throughout their lives potentially facing a 55% tax on their excess pension funds if they withdraw them as a lump sum, or 25% plus Income Tax if they choose to take it as an income.
Read on to discover four tips for how your clients should approach their pension savings once they have breached the LTA.
- Clients should consider applying for individual or fixed protection 2016
Individual and fixed protection 2016 are two options your clients can apply for that help protect their LTA at the value of their pensions as of 5 April 2016, or £1.25 million, whichever is the highest.
Individual protection 2016 requires your clients to have had at least £1 million in their pension as of 5 April 2016.
This scheme allows them to continue building their pension without tax charges provided it remains under the £1.25 million cap. If it exceeds this cap, then charges on their LTA will apply once more.
If they apply for fixed protection 2016 then their LTA will be fixed at £1.25 million, and they can no longer contribute to their pension. This is the preferred option for clients who no longer want or need to contribute to a pension.
To apply for fixed protection 2016 your clients and their employers can’t have made any contributions since 5 April 2016. If your clients do end up making any further contributions, they will lose their fixed protection and will have to pay tax charges on the excess.
- Clients might want to move surplus cash into ISAs
If your client has already breached the LTA – or they are approaching the threshold – they may want to consider alternative savings vehicles.
For example, an Individual Savings Account (ISA) allows your clients to earn interest or returns on cash savings or investments without paying any Income Tax or Capital Gains Tax (CGT). Clients can pay up to £20,000 into an ISA in the 2022/23 tax year.
If you have clients under the age of 40 then a Lifetime ISA will allow them to save £4,000 a year towards retirement, free of Income Tax and CGT, with the government contributing a 25% bonus or up to £1,000 of essentially “free money” each year.
Your client’s Lifetime ISA can be used towards their first home purchase or withdrawn after the age of 60.
The government will continue to make contributions on your client’s Lifetime ISA until the age of 50 or once they reach the lifetime cap of £33,000.
- Clients might invest in Venture Capital Trusts (VCTs) or the Enterprise Investment Scheme (EIS)
Another alternative to saving into a pension is a Venture Capital Trust (VCT) or the Enterprise Investment Scheme (EIS).
VCTs and the EIS are riskier investment options for your clients to consider but do come with their own range of tax-efficient benefits.
VCTs are investment trusts listed on the London Stock Exchange that aim to raise money for fledgling companies to achieve their growth targets. These trusts are made up of usually 20 or more small companies.
As an investor, your client would become a shareholder in the trust itself and would see the value of their investment go up or down depending on the trust’s performance. There is a higher degree of risk associated with VCTs as the companies that make up the trust are young and more susceptible to financial pressures, which could see them go under.
However, VCTs are valuable tax-efficient options as your clients can claim up to 30% Income Tax relief on the amount they have invested in a VCT, provided they hold onto their investment for at least five years.
Additionally, your clients could benefit from CGT relief and tax-free dividends, if the VCT pays out dividends.
Read more about the benefits to your clients of investing in a VCT in our useful guide.
The EIS is similar to a VCT but operates as an HMRC-run scheme that helps younger, higher-risk businesses raise finance from investors.
EIS funds offer your clients a range of tax benefits such as Income Tax relief of 30% on up to £1 million of investments a tax year, or £2 million if at least £1 million is invested in knowledge-intensive businesses such as those in scientific fields.
There is no CGT to pay on the sale of EIS shares held for at least three years and no Inheritance Tax to be paid on shares bought through EIS that are held for two years.
- Clients could choose between an early retirement or continuing contributions
Finally, the easiest way for your clients to avoid any potential charges for breaching their LTAs is to assess whether what they have saved is enough to achieve their desired level of retirement comfort.
If they have saved enough, then they could consider taking an early retirement and enjoying their newfound free time.
Otherwise, if your clients want to continue working and saving, they should consider continuing to make workplace pension contributions even if they might be about to or have already breached the LTA.
While they may have to accept additional tax charges, they will also still continue to receive their employer contributions, which is effectively “free money”, as well as tax relief on the contributions and investment growth on the pension pot itself.
When these returns are combined, your clients might find that they are still better off making contributions even if they do have to pay additional tax charges.
Get in touch
Working with a financial planner can benefit your client in many ways.
A well-written financial plan takes into account events such as breaching the LTA and will ensure your client has the best possible strategy to navigate around the issue while keeping them on course for their long-term goals.
If they would like to find out more, email firstname.lastname@example.org or call us on 0345 505 3500.
The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Levels, bases of and reliefs from taxation may be subject to change and their value depends on the individual circumstances of the investor.
Workplace pensions are regulated by The Pension Regulator.
Enterprise Initiative Schemes (EIS) and Venture Capital Trusts (VCT) are higher-risk investments. They are typically suitable for UK-resident taxpayers who are able to tolerate increased levels of risk and are looking to invest for five years or more. Historical or current yields should not be considered a reliable indicator of future returns as they cannot be guaranteed.
Share values and income generated by the investments could go down as well as up, and you may get back less than you originally invested. These investments are highly illiquid, which means investors could find it difficult to, or be unable to, realise their shares at a value that’s close to the value of the underlying assets.
Tax levels and reliefs could change and the availability of tax reliefs will depend on individual circumstances.
This article is for information only. Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.