Watch out if you save too much for retirement because the tax man is clobbering diligent investors. The lifetime allowance is the amount of cash anyone can save into a pension. The current limit is £1 million and the limit increases in line with the cost of living each year.
Anyone breaking the saving limit pays a tax penalty of 55% on the amount over the cap. An increasing number of savers are paying the pension penalty, according to figures from HM Revenue and Customs (HMRC). In the 2015-16 tax year, when the cap was £1.25 million, HMRC grabbed £126 million from just over 1,500 savers – a jump of close to two thirds over the £78 million paid by 1,482 savers a year earlier.
The figures also revealed that 449 pension savers paid the 55% tax charge in 2015-16, and another 1,100 had to hand over a 25% penalty for withdrawing savings of more than the lifetime allowance as income. Critics point out that a £1 million penalty pot pays a pension of around £50,000 a year, which is an amount many middle-earners can expect for retirement and far short of the pay-out many in the City and industry would expect.
“I think it’s hitting middle England and they don’t realise it. It’s going to hit a lot of public servants and I think it’s really unfortunate. I think it should be removed because it’s detrimental to the whole retirement message and the situation makes it so complex,” said Michelle Cracknell, chief executive of The Pensions Advisory Service. She called for scrapping of the lifetime allowance earlier this year.
Cracknell observed the cap was hitting public servants who could not avoid penalties because they could not control the growth of their funds.
QROPS solution for expats
Expats have a solution with a Qualifying Recognised Overseas Pension Scheme (QROPS). If they can see their fund is about to breach the lifetime allowance, they can shift their retirement cash to a QROPS. Once in a QROPS, the fund can grow in excess of the lifetime allowance beyond the reach of HMRC, as the tax man can no longer demand penalties.
Unfortunately, the government has blocked this escape route for public and civil servants by ordering that their pensions cannot be transferred. However, public or civil servants already transferred and other pension savers with concerns about the lifetime allowance and tax penalties can still switch.