Personal Pension  

The million dollar question

To fund or not to fund? That is the question facing an increasing number of pension savers in danger of breaching the Lifetime Allowance LTA when it drops to £1m this year. This could see them asking some tough questions about how to save for their retirement.

The impact will depend on their individual circumstances. The initial reaction for many will be to stop paying into their pension if this will lead to a tax charge on savings in excess of the LTA.

But a bigger tax bill is not necessarily a bad thing if the net returns available through the pension are still greater than saving elsewhere.

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So what are the key considerations?

Stop fundingContinue funding
Pros: reduces or eliminates the LTA charge on future savings; eligible for fixed protection on existing savingsPros: continue to benefit from their employer’s contribution; continued tax relief from personal contributions at highest marginal rate of income tax; investments will continue to grow tax-free
Cons: ikely to lose the benefit from their employer’s contribution; personal contributions will need to be invested elsewhereCons: savings above the LTA will be subject to an LTA charge of 25% if savings extracted 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

Clearly, one of the key elements influencing choice will be the value of the employer contribution. If funding stops, will the employer stop funding too? And if the employer stops funding the pension, will they offer any alternative form of remuneration?

Fixed protection could mean that up to an additional £250,000 of pension funds are free from the LTA charge. And just a single pound of additional funding will lose that protection. So it is clear that there is a trade-off of an increased LTA against the loss of future funding from the employer. Critical factors will be how near the individual is to their expected retirement date and how close their pension funds are to £1m.

The loss of employer funding

Protection might mean that LTA charges are limited or avoided completely. It could also mean giving up on future pension saving. But it may mean giving up on valuable employer pension funding too.

Employer pension contributions are essentially ‘free money’. Even if they suffer an LTA charge of 55 per cent on their entire future employer funding they will still be better off. They are still receiving 45 per cent of something they may otherwise miss out on.

Some employer contributions are only payable if the employee also pays into the scheme. Even so, it could still make sense to continue their own funding and take the LTA charge on the chin to retain the funding from their employer.

Alternative employer remuneration package

The picture may change if the employer is prepared to offer some other financial incentive instead of making pension contributions.

But it depends on what the alternative offer is. Any alternative package will be taxable in the employee’s hands. And the employer is only likely to provide the employee with a cash compensation which equates to the same net cost of the pension contribution (that is, salary sacrifice in reverse). So the amount of additional salary will be reduced in line with the employer’s additional NI liability.