How to avoid being trapped by the lifetime allowance pensions cap

New research shows more than 1.5 million people are on target to exceed the lifetime allowance (LTA) on pension savings. Many of them are unaware that they could be facing expensive extra tax charges as a result. The research, from pension provider Royal London, warns that the LTA will catch out savers earning much more modest incomes than previously thought.

Under the current rules, anyone who builds up private pension-fund savings worth more than £1.03m including all contributions, tax relief and investment growth has to pay tax on the excess when they begin accessing their money.

The charge is levied at up to 55%. So far, only tiny numbers of savers have been affected by the charge, but a series of reductions in the LTA in recent years has brought more people into the danger zone. With the allowance now due to rise only in line with inflation each year (to £1.055m from 6 April) approximately 300,000 savers who have not yet retired are already above the cap and likely to remain so until they begin drawing down their pensions. According to Royal London, an additional 1.25 million savers are likely to join them over the next few years.

Two groups are at risk

The insurer identifies two groups of people particularly at risk of falling foul of the LTA. More senior public-sector workers in their 40s or older are likely to be members of generous defined-benefit pension schemes (where benefits are guaranteed), which offer such attractive pensions that those on higher salaries are very likely to breach the cap. Better-paid private sector workers with salaries as low as £60,000 are also in danger of breaching the limit.

Such savers face a difficult dilemma. Opting out of further pension saving could make sense for those closing in on the LTA, but this could mean missing out on valuable pension contributions from an employer, as well as tax relief. Even taking into account the tax, some savers will be better off sticking with their pensions and exceeding the allowance.

It may be possible to use other tax-efficient savings vehicles to get around the allowance while continuing to put money by. Individual savings accounts (Isas), for example, offer an annual investment limit of £20,000, but carry no cap on the amount you may build up. Another option to explore is whether an employer would be prepared to remunerate you in a different way if you decide to opt out of its scheme and give up its pension contributions.

What the new tax year means for you

The start of the 2019-2020 tax year on 6 April gives pension savers access to a new set of contribution allowances, and will also mean more generous employer contributions for many.

First, the annual allowance, capping the maximum that savers may pay into their pensions while qualifying for tax relief, runs on a tax-year basis, so the clock is reset on 6 April.

For most people, the allowance is set at the lower of their annual earnings or £40,000 but even non-earners get an allowance of £3,600 each year (so you can contribute up to that amount on behalf of a non-earning partner). Higher earners, with incomes above £150,000, get a reduced allowance.

Contributions above this will be added to your other income and taxed at your marginal rate. If you're worried about exceeding the annual allowance, you may be able to take advantage of the carry-forward rules. These allow you to bring forward unused portions of your annual allowance from each of the past three tax years in order to bolster this year's allowance.

As far as employers' contributions are concerned, the minimum they must pay into their occupational pension schemes rises from 2% of salary to 3% from 6 April. The minimum employee's contribution rises from 3% to 5% at the same time.

Hope for women's pensions campaigners

Campaigners alleging that increases in the state-pension age (SPA) for women were badly managed have won support from the Equality and Human Rights Commission (EHRC). The agency called for the government to introduce transitional arrangements for 3.9 million women affected by the higher retirement age.

Campaigners argue that legislation to raise the SPA for women from 60 to 65 was not properly communicated when it was introduced during the 1990s and 2000s. As a result, they say, many women did not plan for the changes, which were completed at the end of last year, so they were caught out when they discovered they would have to wait longer than expected to start claiming their state pensions.

The EHRC said such complaints were reasonable and urged the government to offer extra help to women affected by the changes. That could include financial assistance for a limited period, as well as a new round of communication. These findings do not compel ministers to take action, but they will encourage campaigners who are preparing for a legal challenge to the government, which will consider whether ministers did enough to inform those affected by the increases. However, ministers are determined to fight their corner. The Department for Work and Pensions has estimated that reversing the changes for women who were born during the 1950s would cost £77bn.