January 2023

The Pension Freedom rules, announced in the 2015 Budget, provided those with Defined Contribution pensions with much greater flexibility and choice as to how to draw their pension. Alongside the announcement of the new rules, the Government launched the Pension Wise service, which provides free and impartial guidance and information for those approaching retirement.

Pension Wise appointment

Anyone aged 50 or over, with a UK based Defined Contribution pension, can book an appointment through the Pension Wise service. The appointments last around 60 minutes and are carried out over the phone or face-to-face through Citizens Advice delivery centres. The purpose of the appointment is to go through the various ways you can access your pension savings and will also cover the tax implications of each option. It will also explain the ability for the pension holder to shop around, particularly in relation to the purchase of pension annuities, and help the user identify pension scams and avoid becoming a victim of what is sadly a growing trend.

Pension providers are now compelled to nudge consumers towards Pension Wise when they make direct contact with a provider to access their pension savings. Prior to June last year, pension providers were only compelled to signpost the Pension Wise service to those accessing their pension; however, the rules have been strengthened, so that the consumer who approaches a pension provider directly must be referred to the Pension Wise service prior to being able to access their pension.

What to do next

It is clear an appointment with Pension Wise may be a positive step and a way of arming yourself with information as to the options that are open to you. However, it is at this point that the crucial decisions need to be taken, where signposting and generic guidance won’t provide the answers.

The introduction of the Pension Freedom rules has undoubtedly been a success and put the control in the hands of individuals as to how they access their pension pot. However, the rules are now significantly more complex, and there are many variables to consider that a guidance service simply can’t take into account. Furthermore, depending on the action taken with the accumulated pensions, there may be no way of undoing a mistake which could prove costly over the long term. This is where independent and holistic advice can help you take the right decisions.

Looking to the long term

One of the first areas to consider is how your pensions are currently invested, and this is beyond the scope of a Pension Wise appointment. Flexi-Access Drawdown remains a very popular way of drawing benefits and this will mean that the pension remains invested for the long term. It is, therefore, crucial that the funds in which the pension pot is invested perform well and offer good levels of diversification. This is where a clear, defined investment strategy provides a significant advantage, although any investment strategy put in place should be reviewed regularly to ensure that the plan remains appropriate for your evolving needs and objectives.

Many people acquire a series of workplace pensions throughout their lifetime and holding multiple plans can make successful investment planning all the more difficult. One option is to combine plans into a single arrangement, and whilst this often provides advantages, it isn’t right for everyone. This is where taking tailored advice, rather than relying on guidance, can look at the specific options and advise on the right path to take.

Watch out for pitfalls

Different pension schemes and arrangements have varying rules, depending on the scheme. Some older style pensions, in particular, carry valuable benefits, such as enhanced Tax-Free Cash, guaranteed annuity rates or growth rates. This may not be immediately apparent from communications received from the pension provider and discovering the finer details of a pension arrangement is an important step to take before looking to draw benefits from a pension. Taking individual advice can discover all aspects of an arrangement and potentially avoid losing a valuable benefit by taking the wrong course of action.

The tax trap

The tax treatment of pension arrangements carries several traps, which the unadvised pension holder could easily fall down. For example, drawing a flexible income could mean that limits are imposed on making further contributions. Pension holders may also wish to access tax-free cash but taking an income may have an adverse impact on their tax position if they are still working. This is where a guidance service can only go so far and is no substitute for personalised advice.

Guidance is limited

Whilst a useful starting point for those approaching retirement, it is important to recognise that a Pension Wise appointment can only offer guidance on the options available. Pension Wise cannot provide advice, which is bespoke and takes into account your personal circumstances. This is where someone who has used the Pension Wise service may question their next steps and moving on to seek independent advice can help structure pension arrangements to suit the retirement you are aiming for.

Please speak to one of our experienced advisers who can provide the right advice tailored to your specific aims and objectives, here.

The value of investments and the income they produce can fall as well as rise. You may get back less than you invested. Past performance is not a reliable indicator of future performance. Investing in stocks and shares should be regarded as a long term investment and should fit in with your overall attitude to risk and your financial circumstance.

Using a pension is a highly tax-efficient way of saving for retirement. Whilst there is no limit to the amount of pension savings that can be built up by an individual, any pension benefits drawn above a stated level are liable to an additional charge to tax. This is known as the Lifetime Allowance, and the allowance currently stands at £1,073,100.

History of the Lifetime Allowance

The Lifetime Allowance was introduced in 2006, and prior to this date, there was no limit placed on the value of pension savings. When introduced, the allowance was initially set at £1.5m and as one might expect, with prices rising over time, the allowance increased to £1.8m in 2012. This was, however, the highest allowance provided, and the allowance was subject to a number of gradual reductions to stand at just £1m by 2016. The allowance slowly increased in line with inflation after this date but was frozen at the current level in 2020. The Budget in March 2022 confirmed this freeze would remain in place until the 2025/26 Tax Year, which will lead to a further real terms reduction in the allowance, when adjusted for inflation.

How to value a pension against the allowance

For those with Defined Contribution pensions, considering the current value of pension savings against the allowance is relatively easy. However, calculating the value of final salary (defined benefit) pensions for lifetime allowance purposes is not so straightforward. For this type of pension, the annual pension accrued is multiplied by 20, although if a separate lump sum is provided by the scheme at retirement, this also needs to be taken into account.

Testing against the allowance

The value of pension savings is tested against the Lifetime Allowance when you start drawing a pension. In the case of a Defined Benefit pension, this will be when the pension comes into payment. For Defined Contribution pensions, this is on each occasion that income, or a lump sum, is taken from the pension. The allowance is also tested if you reach the age of 75 and have pension savings that have not been drawn, or if an individual dies before the age of 75 and hasn’t drawn their pension savings before death.

What is the charge

If your pensions are collectively worth more than the Lifetime Allowance when drawn, you are likely to face an extra tax charge. What this charge will be, depends on how much you exceed the limit by, and also the method by which you draw your pension. If the amount above the allowance is taken as a lump sum, the tax charge on the excess is 55%, or if the excess is taken by way of pension income (for example via drawdown or an annuity) the tax charge is 25%, which is added to any income tax due on the pension income drawn.

Planning ahead

As pension values increase, it is important that individuals consider whether they are likely to face a Lifetime Allowance charge. This is where future planning can be helpful, as an estimate of the likely position at retirement can be calculated by considering an estimate of the likely contributions that will be made in the future, and what growth could be achieved (in the case of a Defined Contribution pension) on the value of the existing pension pot.

Protections exist that enable an individual to benefit from a higher Lifetime Allowance, although there are strict criteria that need to be adhered to in order that the individual benefits from the protection.

Criticisms of the Lifetime Allowance

As tax relief is provided on contributions into a pension, it is reasonable that legislation places certain restrictions to avoid the pension system becoming too generous and costly to the Exchequer. The Lifetime Allowance, however, has long been the subject of criticism, as being punitive and a disincentive to long term saving.

One reason is that the allowance can be considered as a tax on growth, as the value of the pension pot is measured against the allowance when benefits are drawn, with no reference to the amount contributed into the pension.

The Lifetime Allowance has also been cited as a major reason that highly experienced medical professionals are opting to take early retirement. Given that many will breach the Lifetime Allowance by the time they reach 55, highly paid professionals may look to reduce their hours, or leave the profession altogether.  This doesn’t only affect the NHS, it also has an impact on individuals working in other skilled professions, for example the judiciary.

Holistic planning can help

For those who are already affected or may become liable to a Lifetime Allowance charge in the future, there are a range of options that can be considered, including ceasing or restricting contributions or reducing hours (or potentially taking early retirement). For others, it is best to approach the situation by considering methods of mitigating the tax charge that will apply on taking benefits. The crucial point is that one size certainly does not fit all, and this is where independent, holistic advice – taking into account all aspects of an individual’s circumstances – can be beneficial.

It is also important not to leave planning too late, as this affords time to make appropriate decisions.

If you expect to be affected by the Lifetime Allowance or would like to review your existing pension arrangements, please speak to one of our experienced advisers here.

The value of investments and the income they produce can fall as well as rise. You may get back less than you invested. Past performance is not a reliable indicator of future performance. Investing in stocks and shares should be regarded as a long term investment and should fit in with your overall attitude to risk and your financial circumstance.