How to get the better of Labour’s pension raid
If Sir Keir Starmer’s party wins the election, big savings pots could be vulnerable to a return of the lifetime allowance. Lauren Almeida reports
It was less than a year ago that the Chancellor Jeremy Hunt scrapped the £1m cap on how much people can save into their pension tax-free. But as a general election looms and Labour storms ahead in the polls, it may not be long until this tax break is reversed.
This means anyone who has a pension worth more than the old limit could find themselves in a very tricky tax position by the end of 2024.
Excess funds crystallised (to use the industry’s jargon) above the cap could be hit by a tax that has historically been as high as 55pc.
Experts have also said that acting before April 6, the start of the new tax year, would make it harder for Labour’s plans to affect your pension as, if the party wins the next election, Sir Keir Starmer will take office in the following tax year. But there are serious financial implications of cashing in a pension.
Here, Telegraph Money explains whether a new lifetime allowance would affect you, the benefits of “crystallising” your pension before a Labour government arrives and what you could miss out on by doing so.
WHAT IS ‘CRYSTALLISING’? Crystallising your pension means that you free up your investments and get access to your savings either through taking a cash lump sum, buying an annuity or starting to draw a regular income from it (a process known as “drawdown”). Under the old rules, every time you take any benefit from your pension it was tested against the “lifetime allowance”.
WHAT IF YOU HAVE NOT TAKEN OUT ANY TAX-FREE CASH?
You can take 25pc out of your pension as a cash lump sum without paying any tax. While Mr Hunt abolished the overall cap, the amount you can take tax-free was frozen and capped at £268,275, which represents a quarter of the old lifetime allowance. If the lifetime allowance is reintroduced at the same level and you have not taken any tax-free cash from your pension, then it is unlikely you will be hit by a tax bill.
WHAT IF YOU HAVE TAKEN SOME TAX-FREE CASH FROM A DEFINED CONTRIBUTION PENSION?
You may run into some complications if you have taken tax-free cash out of a defined contribution pension scheme. Daniel Hough, of the wealth manager Brewin Dolphin, said: “You would still be able to take up to 25pc of your pot as tax-free cash anyway. Where that may differ is older pensions with enhancements, guarantees and benefits that provide more than most modern schemes – but that largely applies to pensions that would have been accessed pre-2006.
“Someone who has accessed 60pc of their lifetime allowance by beginning to draw on their pension some years ago would still have a good level of headroom left if they have uncrystallised pots to access. That would leave them with around £400,000 still to use and leaving a pot to grow to that level, rather than starting to draw on it, may be the best option.”
WHAT IF YOU HAVE STARTED DRAWING INCOME FROM A DEFINED BENEFIT PENSION? The reason the cap was scrapped was because senior doctors and other medics were retiring early partly because they could no longer add to their pensions. This group has old-style “defined benefit” pensions which now only exist in the public sector.
Using the same figures as the above example, Mr Hough said: “Say the same individual has utilised 60pc of their lifetime allowance (LTA) through a defined benefit scheme only, and received a scheme lump sum of £100,000.
“Under current legislation, they would only have 40pc of their LTA left, or £100,000 of tax-free cash remaining. But post-April 2024, the LTA being abolished leaves maximum tax-free cash of £268,275 and, with a remaining maximum tax-free cash of £168,275 at 25pc, this equates to a pot of £673,100 – much more than £400,000.”
While the lifetime allowance charge was immediately reduced to zero by Mr Hunt when he made the announcement, the cap itself will not be officially abolished until April this year.
WHAT IF YOUR PENSION IS NOW WORTH MORE THAN THE OLD LIFETIME ALLOWANCE?
If your pension is worth more than £1.073m, you could be in the firing line. For savers who are worried about the reintroduction of the cap, then the main options available are going into drawdown, taking a tax-free lump sum, or annual income, depending on whether you have already accessed your retirement savings and what type of pension scheme you are enrolled in.
Take, for example, someone with a £1.5m defined contribution pension.
“With standard benefits, taking a lump sum of just under £219,000 as taxfree cash, they incur a tax liability of £44,000, and their net benefit would be £70,500 a year,” Mr Hough said.
“If they maximise what they withdraw from their pension each year, taking no tax-free cash, it would actually reduce their liability to around £34,000, leaving them with an income of nearly £80,000 per annum.
“Maximising their upfront tax-free cash would increase their tax liability to £42,000 and reduce their annual income to £62,500, but give them a much bigger lump sum of £375,000 to start with and no tax to pay on it.”
DON’T MOVE TOO FAST: INHERITANCE TAX PROTECTION AND TAX-FREE CASH
While the reintroduction of the lifetime allowance may detract from the attractiveness of your retirement savings, remember that a pension is considered separate from your estate for inheritance tax purposes. If you leave money in your defined contribution pension, it is likely that it will be exempt from the death levy. Jon Greer, of the wealth manager Quilter, added that crystallising before the election could affect how much tax-free cash you can draw from your pension under new rules starting in the new tax year.
“One thing that is not widely known about is a transitional tax-free amount certificate,” he said. “Under the new rules taking effect from April 6 2024, it might be possible for people who have already taken pensions to apply for a transition tax-free certificate allowing them to take more tax-free cash in the future than is currently available under the current lifetime allowance regime.
“If you take your remaining uncrystallised rights and put them into drawdown, for fear of incurring a lifetime allowance tax charge in the future, you would not be able to take a tax-free lump sum from your drawdown pension fund. Clearly, there is some complexity here for people with sizable pension funds.”
‘Clearly, there is some complexity here for people with sizable pension funds’