Rising stock markets thrust workers into a retirement tax trap

The number of people breaching the pensions lifetime allowance has risen dramatically after strong investment returns pushed more savers over the cap, new figures have shown.

The lifetime allowance punishes those who have too much in their pension pots with a tax charge of up to 55pc.

Newly released figures from HM Revenue & Customs showed the number of people falling into the lifetime allowance trap was already rising before the Chancellor’s controversial decision to freeze the allowance last year.

There was a 21pc increase in the value of lifetime allowance charges reported in 2019- 20 to £342m, from £283m in the previous year.

HMRC said reductions to tax allowances since 2010 had resulted in a “significant increase” in the number of people breaching the cap.

Becky O’Connor, of the fund shop Interactive Investor, said: “People are contributing more to personal pension schemes and therefore benefiting from more tax relief through their working life, which is a good thing. However, the flipside of this apparently positive picture, particularly for higher earners or those drawing an income or approaching retirement, is the risk of being caught by lifetime allowance charges.”

Unlike Isa savings, where only contributions are capped, the lifetime allowance applies to the overall size of a pension pot. This means rising stock markets can push investors above the limit.

Last year the Chancellor, Rishi Sunak, froze the allowance at £1,073,100 for five years. In real terms, inflation at its current rate will effectively wipe £278,740 off the allowance by 2025.

Just months after Mr Sunak froze the threshold, which previously rose with inflation, the consumer prices index hit a 10-year high. It has now reached 6.2pc – its highest level in three decades.

By the 2026-27 tax year the cap will be £ 186,300 lower than it would have been had the freeze not been put in place, according to calculations using Office for Budget Responsibility forecasts by Sir Steve Webb, a former pensions minister now at the consultancy LCP. This means an extra 400,000 workers will fall foul of the cap, Sir Steve said. While the lifetime allowance was originally designed to affect only the 5,000 wealthiest people in Britain, it will now hit more than 1.6 million. Telegraph Money is campaigning for the lifetime allowance to be unfrozen and increased in line with inflation. Sir Steve said: “A five-year freeze in the lifetime limit for pensions tax relief was always a bad idea, but soaring inflation means it is now a much more brutal attack on pension savers. Large numbers of people who want to build on their existing pension savings will either have to stop saving sooner or face hefty tax penalties.”