Behind the headlines: 1000% increase in tax from Lifetime Allowance breaches over past decade

Early last week, the Financial Reporter shed light on the fact that ‘£110m in tax was collected from individuals exceeding the allowance during 2016/17, compared with less than £10m in 2006/7 when the Lifetime Allowance was first introduced’.

But why has tax collected from those who exceeded the allowance, soared by 1000%?

The Pensions Advisory Service defines the Lifetime Allowance (LTA) as a ‘limit on the amount of pension benefit that can be drawn from pension schemes – whether lump sums or retirement income – and can be paid without triggering an extra tax charge’ (source 2). Anyone who breaches the allowance pays 25% tax on the excess if it is taken as income from drawdown or as a pension and 55% tax if it is withdrawn as a lump sum, this will be in addition to any tax due on any other earnings or income.

Whilst the allowance has fluctuated in recent years, this now sits at £1,030,000 as of April 2018, and is likely to increase in line with inflation at the end of the current tax year (source 2).

So, nothing for us to worry about then? – or so some of us thought. Whilst this won’t affect the majority of people, it is catching a number of us out and HMRC must be having a field day.

Specialist provider of financial education, guidance in the workplace and regulated advice, Wealth at Work, believe that there are three categories that breaching individuals commonly fall into (source 1).

These are referenced by the Financial Reporter as the following:

  • The blissfully unaware

If you have never checked the value of your pension, or did so a long time ago – it’s time to find out what the current value is. Many people in defined benefit (DB) pension schemes are unaware that their pension is valued at 20 times their annual pension for LTA calculation purposes – e.g an annual pension of £30,000 has a value of £600,000 (source 1).

The article continues that, ‘if a member of a DB pension scheme decides to transfer their pension into a defined contribution scheme to take advantage of the pension freedoms, the transfer values offered can be much higher than the standard method of working out the LTA value. For example, transfer values can be as high as 40 times the annual pension, so using the above example, an annual pension of £30,000 could have a transfer value of £1.2m and therefore exceed the LTA’.

  • Those who think they are a long way off

If you’re making healthy pension contributions and these are matched by a valuable sum from your employer – positive pension fund growth and a pay rise might mean you’re not as far from the limit than you thought (source 1).

The example given by the Financial Reporter is: ‘if someone aged 45 has a pension fund of £400,000 and a salary of £50,000, saves 5% of their salary into their pension which rises by 3% p.a and receives employer contributions of 10%, rising by 3% p.a., it is possible for their pension fund to reach £1,670,000 by the time they retire at 65. By this time the LTA is expected to be valued at £1,690,000, showing they are not that far from breaching the limit’.

  • Those who think they are protected but aren’t

And then there’s those who may have already taken precautionary measures to avoid exceeding the limit by opting out of their workplace pension scheme under auto-enrolment – only to be caught in a breach due to enrolment or re-enrolment (source 1).

So where does this all leave us? I’d recommend the following for employers and payroll agents to avoid employees getting caught out by a nasty tax bill:

  • Consider alerting employees, perhaps at the start of the tax year about the resources available to check if they are approaching the LTA and what to do if they have concerns. The Pensions Advisory Service has a number of resources and offers free help and advice
  • They should be reminded to check the combined value of all their pension pots – it can easily add up, particularly if they have multiple pension sources and any DB pensions
  • Think about including a question about lifetime allowance protection on your new starter forms. Don’t assume it only affects senior folk. You have no idea what pension arrangements people have had prior to joining you. Those who haven’t got protection will just ignore the question, those that have will be very grateful you asked. If you don’t, and you contractually enrol everyone into a pension scheme on starting, if they don’t opt-out in the first month their protection will be lost, and the inevitable tax bill will follow and all for the sake of asking that initial question. Remember it is mandatory to tell people they have been auto-enrolled if you have done so via salary sacrifice as that is a contract change.
  • Once you’ve set the ‘exclude from assessment’ marker on your payroll software, make sure it applies at re-enrolment too

If we don’t start alerting employees to the perils of losing LTA protection I fear we might start seeing the rise of significant grievances as employees blame employers for them incurring a tax bill that they had taken steps to avoid. Now we have to be pensions experts as well as employers, there will be times when personal tax liabilities collide with benefits’ packages.