June 5th, 2019.
Potential Pension Tax Traps and How to Avoid Them
For many retirees who have saved up a considerable pot for retirement, the first thing on their mind is how much tax they will pay on their pension. Retirement saving has a number of pension tax relief benefits, but few are aware of the stringent rules surrounding lifetime and annual allowances. Usually, only those with a high amount of earnings or capital are adversely affected by these rules, but as annual allowances are reducing and people are saving for longer increasingly the potential penalties are affecting a broader demographic.
Below, we list which pension traps to be aware of.
Pension Protections and Transfers
Pension protections are there to preserve an individual’s pension lifetime allowance from reductions in limits. These protections, though, are fragile under certain circumstances, especially if you accidentally enter an employer’s pension scheme or other such related schemes.
If this happens, the protection could be immediately lost, and potential tax bills unintentionally incurred. For protections, then, keep an eye on your employer’s pension scheme changes, and make sure you’re not enrolled in them without taking financial advice in advance.
Pension contributions can accidentally accrue tax charges too. Namely, look out for cash lump sum additions, as this can push you over both annual and lifetime allowance caps.
Lifetime Allowances Are Fragile
The lifetime allowance cap is the amount of savings a person can have before potential tax penalties may start rearing their ugly head. Until 2020, the cap is £1,055,000.
On paper, this figure is so high that it can lead to some pension savers ignoring it. However, what savers often find is that once they factor in benefits, such as death in service or increased transfer values from defined benefit schemes, their total retirement savings can be a lot higher than expected.
So, when saving, keep this cap in mind. Pure Wealth Management can advise on how to save in a way that makes the most of your pension tax relief, or else your auto-pilot savings could cost you.
Annual Allowances and Earnings
When adding to your pension pot, there are limits to tax free additions too. The tax free limit for 2019/2020 is £40,000 a year (dependant upon your income), but it does come tied-up with some complicated exceptions. So, if you have income in excess of £110,000 a year you may be subject to a reduction in the amount you can save each year. In the case of high-income earners, this can reduce your annual allowance by £1 for every £2 of earnings in excess of £150,000. This is only one part of the tapering rules which are complicated, so do need exploring on a case by case basis.
The Impact of Age
Sadly, the motto “you’re only as old as you feel” doesn’t apply to tax law. Once you hit 75, tax treatment for pensions left upon death change. Therefore, if you’re still under 75, it will be worth organising your savings to ensure that they are being used in the best way for you now and can be left to who you wish, how you wish, when the time comes.
Whether you’re an Employer or an Individual, if you would like to learn more about pension tax traps, our friendly and knowledgeable team can help. Get in touch today to take control.