How new pension contribution rules will affect youDB scheme pensions to be capped at £62,500
20 December 2012
Government plans to cut the maximum amount people can take from their pension over their lifetime from £1.5m to £1.25m, combined with a reduction in the tax-free contribution allowance from £50,000 to £40,000, look set to make UK pensioners' lives even harder.
Pensions lifetime limit
Chancellor George Osborne announced the changes to the lifetime limit in this month's Autumn Statement. Members of defined contribution (DC) schemes are unlikely to be affected, because the £1.25m cap applies to the value of the pension, and most people don't build up DC funds of this size.
However, it's bad news for defined benefit (DB) scheme members. For the purpose of calculating the lifetime allowance, the benefits of the scheme (the pension value, but also lump sums and death benefits) are multiplied by 20 to give an overall value that the lifetime allowance can be compared to. Find out about the difference between DB and DB schemes in our guide, Company pensions explained.
Maximum salary in a defined benefit pension scheme
For a DB scheme, a £1.25m cap is equivalent to a pension of £62,500 per year without a lump sum or £46,000 if the 25% tax-free lump sum is taken. According to calculations by Which? Money, the maximum salary you can earn before hitting the lifetime allowance cap is £93,750 a year.
People can exceed the £1.25m cap, but they'll be hit with a one-off 25% tax on the exceeding amount plus usual income tax on the remainder. Alternatively, you can take the exceeding amount as a lump sum – but you'll be subject to 55% tax.
Pensions annual contribution limit
Cuts to the amount people can save into their pensions per year on a tax-free basis has also been cut. The maximum will be £40,000 from April 2014, £10,000 less than the current £50,000 limit. The allowance was cut from £255,000 to £50,000 in 2011.
It's expected that wealthier people will ramp up their saving in order to get more money in the bank before the new rules come in. Savers are allowed to carry forward unused allowances from the past three years, and if you haven't made any use of tax relief in the past three years, you can contribute up to £200,000 before the annual allowance is cut.
Who's affected by the new pension rules?
The Treasury estimates that 360,000 people will be affected by the change to the lifetime allowance. It also expects 30,000 of these people to have pension assets worth between £1.25m and £1.5m in 2014/15, meaning that they will be caught between the new and old rules.
The Treasury predicts that up to 140,000 people will be affected by changes to the annual allowance. In his Autumn Statement speech, Mr Osborne said: '99% of savers make annual contributions to their pensions of less than £40,000. The average contribution is just £6,000 a year.'
Alternative pension saving solutions
Isas are one alternative being touted by the experts. They're flexible – you can either choose a cash Isa or a stocks and shares Isa, depending on your attitude to risk – and their tax rules are much simpler than those of pensions. Isas also offer instant access to your savings.
Venture capital trusts, or VCTs, are another option for higher earners. VCTs invest in companies that aren't listed on the London Stock Exchange, meaning they are higher risk. In return for investing in these riskier companies, the government gives tax breaks to investors – you get 30% tax relief and you don't pay capital gains tax (CGT).
You could also use your property to fund your retirement. Equity release involves freeing some of the value in your home, which you can use to partly pay for your retirement. It also helps mitigate CGT. However, equity release isn’t suitable for everyone, so get financial advice before you take it.