Meanwhile, drawing income that exceeds the LTA will be subject to a 25% tax charge on top of your marginal rate of Income Tax.
Fortunately, since 2006, pension savers have had the option to apply for LTA protection, helping to reduce the chance of incurring this bill.
However, according to research from consultancy firm LCP published in FTAdviser, the number of people making use of LTA protection has declined since its inception, falling to just 4,000 people in the most recent year.
This could be because savers aren’t aware of the benefits of LTA protection or are even unaware that it exists at all.
So, here’s everything you need to know about LTA protection to help you decide whether it might be the right option for you.
What is LTA protection?
LTA protection allows you to fix your pension allowance at a slightly higher threshold than the current level of £1,073,100, depending on the value of your pension savings at certain times.
The reason LTA protection exists is because of how the government has changed the LTA threshold over the past few years.
In the 2010/11 tax year, the LTA reached an all-time high of £1.8 million. However, it then steadily reduced over the following years, falling to just £1 million by 2016/17. It subsequently rose to its current level of £1,073,100 in April 2020, where it will now be fixed until April 2026.
This meant that many savers would have seen their pot suddenly exceed the threshold when it was reduced in 2016, despite not having deliberately crossed it.
As a result, the government introduced LTA protection to ensure savers who had already crossed the threshold were not unfairly penalised.
Two types of protection
There are two different types of LTA protection, allowing you to protect your savings from the reduction to £1 million in April 2016:
Individual protection 2016
Individual protection allows you to fix your LTA to either the value of your pension savings as of 5 April 2016 or a fixed level of £1.25 million, whichever is lower.
If you use individual protection, you can continue to build up your pension savings pot. However, it’s crucial to note that any savings over your new limit will be subject to the 25% or 55% tax charge, depending on how you draw them.
Fixed protection 2016
Fixed protection allows you to fix your LTA at the 2016 level of £1.25 million.
The key difference to individual protection is that you cannot continue to build up your pension pots, except in limited circumstances.
If you do contribute more to your pot after taking fixed protection, you’ll lose your increased LTA entirely. This means you’ll revert to whatever the current LTA is in that tax year.
You’ll then be subject to the 25% or 55% tax charges when you come to draw any value over the threshold from your pension.
Is LTA protection worth it for you?
Provided that you’re eligible for LTA protection, it could make sense for you to protect your pot. This is especially true if you’re right on the cusp of retirement, potentially saving you from a tax bill right before you draw your savings.
Of course, as you can imagine, LTA protection may not solve all your issues as there are a couple of downsides.
If you’re still working and saving into your pension, you may still find yourself exceeding the LTA, even with the higher protected amount.
Most significantly, if you use fixed protection, you won’t be able to make any more contributions to your pension. If you decide to do this, this could mean you end up missing out on employer contributions and potential investment returns.
Alternatives to LTA protection
Of course, depending on your retirement plans, you could also consider saving for retirement across a range of different products alongside your pension.
For example, you may want to consider maximising your ISA subscriptions each tax year, giving you a way to save that’s entirely free from Income Tax and Capital Gains Tax (CGT).
This could allow you to keep building savings dedicated for retirement without having to worry about the LTA tax charges.
Taking LTA protection may still be a worthwhile exercise even if you decide to explore your other options. It may allow you to make even greater use of your pension savings, even if you stop contributing to your pot.
Working with a financial planner
If you’d like help working out whether LTA protection is the right choice for you, please get in touch with us at Bowmore Financial Planning.
Email enquiries@bowmorefp.com or call 01275 462 469 to speak to one of our experienced advisers.
Please note
The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Levels, bases of and reliefs from taxation may be subject to change and their value depends on the individual circumstances of the investor.
Workplace pensions are regulated by The Pension Regulator.
