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Jul 8, 2021

Thousands of savers caught out by pension tax traps

More savers breached the annual allowance and lifetime allowance in the 2018/19 tax year, recent figures published by HMRC show.

A total of 32,440 people reported saving more in their pension pots than the £40,000 annual allowance in 2018/19, triggering tax charges that totalled a value of £817 million.

The number of people who exceeded their annual pension allowance was 14% higher than in the previous tax year, when 29,910 savers were caught out.

If they have breached the allowance, savers can either pay the tax charge either through an accounting-for-tax (AFT) return, or via a self assessment on or before 31 January.

The number of AFT returns saw a significant increase, accounting for £209m of the annual allowance charges in 2018/19 - up 71% on the £122m reported in 2017/18.

Andrew Tully, technical director at Canada Life, said:

"Even something which sounds as simple as an annual allowance is complicated by the fact we have three different limits.

"This complexity means many individuals may be unintentionally caught by the annual allowance, although this should ease in more recent tax years due to the rise in the tapered annual allowance threshold."

Caught out by lifetime allowance

More savers were also caught out by the lifetime allowance over the same period, while the tax charges for doing so grew over the same period by 6% from £269m to £283m.

The total amount of pension benefits that could be drawn from a pension pot in 2018/19 stood at £1.3m.

Above this, a total charge of 55% applied on excess funds that were taken out as a lump sum, while a 25% charge applied if excess funds were taken as retirement income, which was taxable at the marginal income tax rate.

On this, Tully added:

"Interestingly, most savers chose to pay the tax charge of 25% and retain the money in the pension, rather than opt for the rather more salty lump sum charge of 55%.

"Freezing the lifetime allowance [at £1,073,100] for the next five years will mean more and more people will get caught by this relatively arbitrary figure."

NHS staff opting out of pension schemes

A key sector in which staff have been especially hit by tax bills because of concerns surrounding the tapered annual allowance.

If a high net-worth individual's threshold income is over £200,000 and their adjusted income is more than £240,000, the taper applies at a rate of 50% on excess income down to £4,000.

One result of the system is that many high-earning doctors and medical professionals are leaving the NHS pension scheme to save money because they are likely to be hit by tax charges.

In the 2019/20 tax year, a total of 50,399 NHS workers opted out of the scheme, up 22% from the previous year when 41,219 left.

Since the tapered annual allowance system was introduced in 2016, about 180,000 staff have left the scheme in total.

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