A client recently asked if the lifetime allowance means there comes a point when it doesn't pay to make further contributions to a pension. For some investors the answer is yes, but it does depend on your circumstances.
HM Revenue & Customs offers significant tax benefits to incentivise pension savings. However, this generosity isn't limitless. There's a cap, known as the lifetime allowance on the total you can hold in pensions (in addition to the rules on how much you can contribute each year).
The lifetime allowance is currently £1.5 million – but it will reduce to £1.25 million from 2014/15. Your pension is measured against this limit when you take benefits or reach age 75, whichever is sooner, and any excess could be subject to a 55% tax charge.
Regular contributions and investment growth over decades could mean you're more likely than you might think to fall foul of this upper limit. For example, a pension worth £750,000 today would exceed the £1.25m lifetime allowance in just ten years, with 5.5% annual growth after charges.
How much could your pension be worth at retirement? Our free pension calculator helps you find out »
(ensure you view your results in 'money terms' rather than 'today's terms')
What are your options?
1. Stop paying into the pension and "protect"
Stopping pension contributions could work well for investors very close to the new £1.25 million limit or those who think investment growth will get them there based on the current value of their pensions, although remember investments will fall as well as rise in value.
The government is planning to introduce the option to apply for a special treatment – pension protection – that allows some investors to be treated as though they have a higher lifetime allowance. HMRC is expected to publish the relevant form in the summer of 2013. If you want to keep up to date with the latest rules when they're announced, please register your interest and we'll contact you as soon as details become available.
2. Keep contributing, review carefully
The alternative is to continue contributing and monitor the value of your pension carefully, aiming to keep it below the lifetime allowance. The potential for a 55% tax charge means investors would receive less than half of any investment gains above the lifetime allowance. Investors in this position should therefore consider switching to less risky investments with lower potential growth to balance this limit on their investment return.
3. Keep contributing and pay a tax charge
The tax charge only applies to the excess over the lifetime allowance. Investors could decide to continue contributing beyond this limit, if the benefits outweigh the tax charge. For instance, if an investor is a member of a final salary pension scheme or a scheme where employer contributions are considerable, the additional tax could be a price worth paying.
Please remember, the amount of tax relief will depend on your own circumstances and tax rules can change over time.
How can we help?
If you think the lifetime allowance could affect you, download our lifetime allowance factsheet to find out more.
Use our pension calculator to get an idea of the potential value of your pension at retirement. You can then see whether the 'money terms' value is over or under the new lifetime allowance, £1.25 million. You can also use the calculator to adjust the contribution rates and the assumed growth rate to help with your planning.
If you're still unsure you could take advice from our expert independent financial advisers.
The value of investments can go down in value as well as up, so you could get back less than you invest. It is therefore important that you understand the risks and commitments. This website is not personal advice based on your circumstances. So you can make informed decisions for yourself we aim to provide you with the best information, best service and best prices. If you are unsure about the suitability of an investment please contact us for advice.