The Spring Budget announced that the Pension Life Time Allowance (LTA) would be frozen until at least April 2026 at £1,073,100. Previously, the LTA increased at the target rate of 2.5% however last year due to the low inflationary environment, it only went up by 0.5%. A prolonged period with no inflationary increases will mean that more and more people will face LTA charges.
Life Time Allowance charges are applied on the amount over the LTA – at a rate of 25% plus the marginal income tax rate for income, or 55% if someone takes the excess as capital all in one.
It is important to remember that the LTA is not a ceiling on what can be saved into pensions. There are good reasons why even those who are affected should continue saving into their pension, particularly if stopping personal contributions means losing out on employer contributions.
The loss of employer funding is clearly key, as it is essentially free money. Even if it does suffer an LTA charge of 55% – 45% of something is better than 100% of nothing. Luckily, some employers are now offering alternative packages in the form of additional salary, which can then be invested into ISAs or other tax-efficient investments.
You should only give up on saving into your pension if there is a better alternative. So, if the net returns on pension savings, including employer contributions and pension tax relief, are greater than the alternative, then an LTA charge may be a price worth paying.
Although the LTA freeze will affect the wealthiest individuals immediately, there will also be a drag effect further down the line for many middle-earners, who may not necessarily see it as a problem at the moment.
This is because when the Life Time Allowance does increase again in five years’ time, it will be starting from a lower base, resulting in more people reaching the limit in the future.
As the concept of retirement continues to change, many people will choose to carry on working well into their mid-60s and beyond. So, by paying into a pension and investing for longer, there is a much higher probability of reaching that Life Time Allowance.
This means that younger investors should start to think about their Life Time Allowance way before it starts to become a problem. With careful planning and the use of a wide range of alternative investments, it is possible to mitigate at least some of the effects of the freeze in the allowances.
At Foresight, we deal with many people who have Life Time Allowance issues. We have specialist software that allows us to predict pension fund growth. Our expertise allows us to help you plan for the most efficient way of extracting income in retirement.