Lifetime allowance proves pensions headache

though the rules are different, meaning that you can earn £50,000 a year before you breach the lifetime allowance.

Unsurprisingly this has led to calls for an equalising of the tax treatment of the two groups, with some arguing that the lifetime allowance should be scrapped altogether because the annual cap – currently £40,000 – is sufficient.

Go over either the annual or the lifetime allowance limit and HM Revenue & Customs claws back the tax relief that is added to all pension savings.

The charge is 25 per cent on any income taken, and 55 per cent if taken as a lump sum.

Certain protections were introduced for some at the time the lifetime allowance reduced to £1 million in 2016, but were baffling for the layman, leading to widespread confusion among savers as to if and when they would breach the limit. The protections involved “individual” and “fixed” versions.

The former could be applied for only if the value of savings was at least £1 million in April 2016, allowing you to retain the lower of your pension value at that date or £1.25 million. There was no minimum pension value required for fixed protection, which also allowed you to keep the £1.25 million allowance. But making any new pension contributions afterwards voided the protection and saw the allowance drop back to £1 million. Yes, as clear as mud! All private pension saving counts towards the lifetime allowance. The state pension is excluded from the calculation.

So how do you work it out, especially if you have both defined benefit and defined contribution savings, as an estimated 10 million workers do?

You have to add your defined contribution savings to any entitlements to a defined benefit scheme.

In the case of the former, you simply take the current value of your pension, as found on your annual pension statement or on request from your provider.

Defined benefit savings work differently, however. You multiply your projected initial yearly income by a factor of 20 for each defined benefit scheme you are a member of, then add any defined contribution savings.

It is up to individuals to keep track and it is easy to get caught out.

Steve Webb, director of policy at pensions company Royal London, noted: “The fact that people can accidentally breach the lifetime limit for pension tax relief shows how absurdly complex the whole system has become.

“Growing numbers of people will now have a mix of final salary pensions from previous jobs and new pension pots that they are building up with their current employers.

“Understanding how to combine these two different sorts of pension and test them against HMRC limits should not rely on individual pension savers having to dig out the relevant rules and perform complex calculations.

The whole system of lifetime and annual allowances would benefit from radical simplification, and preferably the abolition of the lifetime limit altogether.” My sentiments entirely. Trevor Law is managing director of Merito Financial Services, chartered financial planners,

based in Solihull. Email:tilaw@meritofs.com