Ignore the lifetime allowance and take the tax hit

There’s been a lot of wailing about the extra tax burden once you hit the pensions lifetime savings allowance. But it’s better to just carry on contributing and pay the tax, says Merryn Somerset Webb.

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.

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.

Recommended

Should you defer your pension and stay in work?
Pensions

Should you defer your pension and stay in work?

The pros and cons of deferring your pension and staying in employment beyond 66 are finely balanced.
15 Sep 2021
I wish I knew what a marginal tax rate was, but I’m too embarrassed to ask
Too embarrassed to ask

I wish I knew what a marginal tax rate was, but I’m too embarrassed to ask

Your marginal tax rate is simply the tax rate you pay on each extra pound of income you earn. Here's how that works.
14 Sep 2021
Why the government's plan for funding social care is a lousy one
UK Economy

Why the government's plan for funding social care is a lousy one

Insisting that people use their property wealth to pay for social care is perfectly reasonable, says Merryn Somerset Webb.
10 Sep 2021
State pensioners probably aren’t going to get an 8% pay rise next year
State pensions

State pensioners probably aren’t going to get an 8% pay rise next year

The “triple-lock” could in theory mean an 8% rise in state pensions this year. But that’s not going to happen. Saloni Sardana explains what the triple…
6 Sep 2021

Most Popular

The times may be changing, but don’t change how you invest
Small cap stocks

The times may be changing, but don’t change how you invest

We are living in strange times. But the basics of investing remain the same: buy fairly-priced stocks that can provide an income. And there are few be…
13 Sep 2021
Two shipping funds to buy for steady income
Investment trusts

Two shipping funds to buy for steady income

Returns from owning ships are volatile, but these two investment trusts are trying to make the sector less risky.
7 Sep 2021
Should investors be worried about stagflation?
US Economy

Should investors be worried about stagflation?

The latest US employment data has raised the ugly spectre of “stagflation” – weak growth and high inflation. John Stepek looks at what’s going on and …
6 Sep 2021