Issues with Million Pound Pensions: Potential Lack of Tax-Free Cash Benefits
In a significant shift for pension savers, the UK government has introduced changes to the tax-free cash limits, which came into effect in April. The reforms, which have been labelled a "stealth tax" by wealth manager Quilter, could have major consequences for those who have accrued significant pension wealth.
The lifetime allowance, the amount you can put into workplace pensions and self-invested personal pensions (Sipps) without facing a tax penalty, has been reduced. As of April, the lifetime allowance stands at £268,275, with a maximum limit of £268,275 tax-free cash. Exceeding this limit results in a tax penalty of up to 55%.
The money purchase annual allowance (MPAA) is another factor to consider. This allowance is triggered when money is withdrawn from a pension, reducing the maximum annual pension contributions from £60,000 to £10,000.
Savers with defined benefit pension schemes may need to consider more complex planning to protect their tax-free cash amount. Taking professional advice is critical in such cases. Crystallizing a pension earlier than planned can result in the loss of inheritance tax status for the withdrawn money.
If a pension pot grows to £1.5m in the next few years, the cap on the tax-free cash will remain at £268,275, which is the equivalent of just 18% of the nest egg. This means that savers typically receiving 25% of their pension pot tax-free could see this reduced to just 10% over the next decade.
About 1.6 million people are expected to breach the previous lifetime allowance by 2026. For those who find themselves in this position, it's crucial to understand the implications and seek professional advice.
In last year's March Budget, the former chancellor, Jeremy Hunt, announced the scrapping of the £1,073,100 lifetime allowance. The new British Finance Minister, Rachel Reeves, could reveal changes to pensions in the autumn Budget on 30 October, including potentially cutting pension tax relief, reintroducing the lifetime allowance, or lowering the amount of tax-free cash that can be taken.
In the meantime, utilising other products like ISAs and insurance bonds can help maintain advantageous inheritance tax status and control the tax payable. Insurance bonds, in particular, can simplify tax reporting and serve for inheritance tax planning purposes.
It's clear that these changes to pension tax-free cash limits require careful consideration from savers. As always, seeking professional advice is strongly advised.
