Individuals with larger pension funds could risk losing a large chunk of tax-free money from their pension if they fail to take action following the recent pension allowance reforms, warns Quilter.
In March, Chancellor Jeremy Hunt announced he would abolish the pensions lifetime allowance, which had capped the total amount savers can hold in their pensions tax-free at £1,073,100. While previously, people could take the lower of 25% of their pension fund or 25% of the lifetime allowance as a tax-free lump sum, the new reforms set a new maximum limit of £268,275.
Quilter said those who have reached or are set to reach the previous lifetime allowance will see the amount of tax free cash available to them shrink both in percentage terms and in purchasing power as their pension grows. Over five years, they could lose nearly £37,000 of available tax-free cash at retirement in real terms, with 81% of their pension becoming subject to tax on withdrawal. Over 10 years, the real value of tax-free cash could shrink by almost £70,000.
According to Quilter, those with large pension funds are facing a crystallisation conundrum, having to make a decision whether to crystallise earlier than planned and invest their tax-free cash in other products like ISAs and insurance bonds to protect and make their tax-free cash rights work harder.
Roddy Munro, head of tax and pensions specialists at Quilter, said: “With savers already impacted by fiscal drag as well as the reduction in the capital gains annual exempt amount and the dividend allowance, now those with large pension funds will soon feel the full effect of the freezing of the amount they can take tax-free from their pensions.
“The impact of the Chancellor’s recent visits to the dispatch box will have major consequences for those who, through careful financial planning, have accrued significant pension wealth. The practice of fiscal drag, where tax thresholds and allowances do not keep track with increasing inflation or wage growth is not widely appreciated. The government is banking on general ignorance of the impact of such fiscal drag to increase the tax take by stealth, but people can act as there are a number of ways to avoid these Machiavellian reforms.”
While individual circumstances will differ, Quilter said those who decide to take their tax-free cash earlier and utilise other products should consider ISAs and insurance bonds to shield their savings.
Munro added: “Around 1.6 million people were set to breach the previous lifetime allowance by 2026 with many more set to breach it in years to come. Now, some of these will include defined benefit pension holders where they have a different set of rules to contend with, but those in more common defined contribution pension schemes will now have to consider more complex planning to protect their tax-free cash amount.
“This is against the backdrop of an election year in 2024, which could see Hunt’s pension reforms reversed if Labour come to power. The best outcome for consumers will very much be driven by their own and their family’s circumstances, so taking professional advice will be critical.”
