Ignore the lifetime allowance and take the tax hit

published 31 January 2019

190131-lifetime-allowance — Do the sums - it's better to keep paying in to your pension

There's been some fuss recently about the miseries of those hitting their annual and lifetime pension limits (£40,000 tapering down to £10,000 for high earners and £1.03m respectively) and having to pay taxes as a result.

Most of the commentary around the issue has been about ways to avoid paying those taxes mostly by leaving schemes or cutting contributions. But there was a sudden outbreak of common sense in the papers at the weekend; in the Mail and in the Telegraph, Sally Hamilton and Laura Miller both asked whether paying the extra tax might be worth paying after all, paying tax on something usually suggests that you have something in the first place and at least some of the something left at the end.

Hamilton runs some numbers. A 50-year-old saver has a salary of £215,000 which gives them an annual allowance of only £10,000 and hopes to retire in ten years. Their employer pays 6% into their pension. They pay the same so £12,900 each and a total of £25,800. Whoops. £15,800 of the contribution ends up taxable at 45% a bill of £7,110. But this leaves £18,690 invested.

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

https://cdn.mos.cms.futurecdn.net/flexiimages/mw70aro6gl1676370748.jpg

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Say it grows at 4% a year in real terms, it will be worth £27,665 in a decade. So an effective personal contribution of only £7,095 (£12,900 after the tax relief) ends up being worth rather more. Staying in the scheme under circumstances such as this, as Hamilton quite rightly says, a "no brainer".

You can do similar sums with defined-benefit pensions and with the lifetime allowance for both types of pension, but in each case the key game-changer is your employer's contribution which is effectively (from the employee's point of view, anyway, free money). Leave the scheme and you lose that which rarely makes much sense (although you can of course attempt to attempt to negotiate a pay rise in lieu).

It's also worth noting, says Miller, that being inside a pension scheme often comes with extra benefits, such as life insurance and a pension for dependents should you die, and that the generosity of these schemes can change if you are no longer an active member of the scheme.

This is important stuff if you are over your allowances and are wondering quite what to do, reading this from Royal London will be a good start. You might also read this it makes an interesting case for ignoring the lifetime allowance completely if your plan is to pass your pension on to your heirs intact. This comes with the usual warning the lack of IHT on pension assets is such a generous part of the current pensions regime that we would be amazed if it lasted a generation.

Merryn Somerset Webb started her career in Tokyo at public broadcaster NHK before becoming a Japanese equity broker at what was then Warburgs. She went on to work at SBC and UBS without moving from her desk in Kamiyacho (it was the age of mergers).

After five years in Japan she returned to work in the UK at Paribas. This soon became BNP Paribas. Again, no desk move was required. On leaving the City, Merryn helped The Week magazine with its City pages before becoming the launch editor of MoneyWeek in 2000 and taking on columns first in the Sunday Times and then in 2009 in the Financial Times

Twenty years on, MoneyWeek is the best-selling financial magazine in the UK. Merryn was its Editor in Chief until 2022. She is now a senior columnist at Bloomberg and host of the Merryn Talks Money podcast - but still writes for Moneyweek monthly.

Merryn is also is a non executive director of two investment trusts – BlackRock Throgmorton, and the Murray Income Investment Trust.