It's important to remember that the LTA isn't a ceiling on what can be saved into your pension plan. Even as you near the threshold, there are potentially many good reasons why you might continue saving into your pension in the new tax year, especially if stopping funding means losing out on contributions from your employer.
Why a pension may still be a good place to save for retirement despite a potential LTA charge
A pension plan has the potential to deliver investment returns. This plus any employer contributions that you may receive, could make saving your money into your pension more beneficial for you than saving your money elsewhere; possibly making an LTA charge a price worth paying.
- When faced with the prospect of exceeding your LTA, there are difficult questions to be considered;
- Should you give up your employer pension contributions?
- Does carrying on paying matching contributions make sense?
- Can you benefit from extra salary in exchange for pension contributions and if so, will you be better off?
- Should you stop paying into your pension plan if this will lead to a tax charge on savings in excess of the LTA?
The best course of action will depend on your individual circumstances, always speak with your Financial Planner to understand the best way forward for you.
This list summarises things to consider when making the decision to exceed the LTA.
✔ You'll reduce or eliminate the LTA charge on future savings.
✔ 'Fixed protection' may still be available, but only if you haven't made any contributions since 5 April 2016.
✘ You will lose the benefit of any employer contributions if applicable.
✘ You'll have new decisions to make on where to invest your personal contributions instead and may need to pay tax on any income and gains.
✔ You'll continue to benefit from any employer's contribution.
✔ You'll still get tax relief on their personal contributions at their highest marginal rate of income tax if total contributions are within your annual allowance.
✔ Investments could still have the potential to grow tax free.
✘ Saving above the LTA will be subject to an LTA charge of 25% if savings are taken as taxable income (or 55% if the surplus is taken as a lump sum).
✘ None of the surplus can be taken as tax free cash.
Do you benefit from employer contributions?
It is important to weigh up the value of any employer contribution that you receive versus any LTA tax charge you may face. Many employers offer matching contributions. So if you stop paying in, your employer might too.
Employer contributions don't ‘cost’ you anything in the sense that they are paid for by your employer, not out of your salary. Even if you face an LTA charge of 55% on your entire future employer funding, you’ll still be benefiting from 45% of something you would otherwise miss out on. It may therefore make financial sense to continue paying in, despite the LTA charge.
Does your employer offer an alternative remuneration package?
Some employers can offer additional salary instead of making pension contributions.
Depending on how much your employer may be prepared to offer, and whether it equates to the pension contributions you would otherwise receive, you may wish to consider this if available to you.
If you do choose to take the additional salary and you're looking to use the additional money to save for your retirement, the question is where else aside from your pension plan could you invest it? There are various options available such as Individual Savings Accounts (ISAs) or mutual funds. Your Planner can help you decide which option best suits your own personal circumstances. They can also help you consider any long-term impact as well. For example, if passing on wealth to the next generation is important to you, your pension is generally Inheritance Tax (IHT) free, whereas other savings vehicles such as an ISA or offshore bond will form part of the estate for IHT.
Making personal contributions that result in an LTA charge
Continuing to pay into your pension over and above the LTA can make sense where you will continue to benefit from employer contributions. But what about making contributions to a personal pension plan which will result in an LTA charge? There's something that feels slightly uncomfortable about paying contributions knowing that an additional tax charge will be applied. What really matters though is what you will get back after all taxes have been deducted. Again, this is where your Planner can help. They can help you understand what you’ll get back will depending upon your own personal tax position, and whether it is worth continuing with personal contributions.
It's only natural to want to limit tax charges of any kind, especially one designed to act as a cap on funding. But it's always important to look at all the options. The alternatives will generally have their own tax consequences to be worked through before arriving at the most suitable outcome. Your Planner is always on hand to help with any queries that you have so do not hesitate to get in touch.
Laws and tax rules may change in the future and the information here is based on our understanding in April 2021. Personal circumstances also have an impact on tax treatment. Investments can go down as well as up meaning you may get back less than you put in. The information in this blog should not be regarded as financial advice.