A pension pot of Â£1 million may sound attractive, but it could have a number of unexpected drawbacks.
Research by The Sunday Times in January 2018 suggests there are 900,000 people currently in work in the UK who already have this amount in their pension. And people who have reached this could face tax charges of 55%.
This has been exaggerated by a steady reduction in the lifetime pension allowance, which shrunk to Â£1 million in 2016 – although this is set to rise again to Â£1.03 million in April this year.
Antony Barton, IFA at Robertson Baxter believes that there are a few ways to mitigate charges on pots approaching or over Â£1m
“To protect a fund approaching Â£1 million, an individual could reduce their personal contributions and/or the contributions of their employer, and receive these as cash instead,” said Antony.
“While this would slow the growth of the fund, an individual’s employer does have to agree with this arrangement and it is a possibility that a loss will be made on the cash due to income tax.”
“Investing in lower returning investments may be tempting as your fund approaches the lifetime allowance, but it is still be worth targeting higher growth – 45% of something is worth more than 100% of nothing.
“Not trying to get a good return because of tax is akin to not working because you’ll have to pay tax. This however is dependent on your own personal situation,” he added.
“There is also the option to take the tax free lump sum – the current rules permit up to 25% tax free cash from an individual’s pension pot. This means that if you have a pension pot of Â£1 million, that’s up to Â£250,000 tax free. The remaining Â£750,000 is placed into draw down.
“At this point you will have reached 100% of your lifetime allowance. However, you can continue to withdraw gains regularly to avoid the tax charge, accepting you will pay income tax on these withdrawals at your highest rate.”
People also have the option of defined benefit or final salary schemes which guarantee an income depending on age and service for individuals enrolled on these schemes.
“To calculate whether the lifetime allowance is reached, an individual must times their income by 20, and any tax free cash is added,” added Antony.
“For example, if an individual has a guaranteed pension of Â£50,000pa then this individual will have hit the Â£1 million level.
“A possible way around this is to take the tax free cash lump sum and a reduced income instead. For example, a one off payment of Â£120,000 in return for a lower Â£40,000pa income would value your fund at Â£920,000 (Â£40,000 x 20 plus Â£120,000).