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Pension allowances: why they matter

Justin Urquhart Stewart, Co-Founder and Head of Corporate Development

On 22 November, Philip Hammond as Chancellor of the Exchequer will present the first Autumn Budget to parliament.

And while many may remember his U-turn in policy with regard to the national insurance contributions (NICs) for the self-employed in the last (spring) budget, most will not have noted that the dividend allowance was still cut from £5,000 to £2,000 from the 2018/ 19 tax year. While it was in the same raft of measures as the NICs changes, I am quite certain that it won’t have been mentioned once in The Sun’s White Van Man campaign to help overturn Hammond’s decision. This is despite its very important implications for the self-employed.

Meanwhile, in-between Hammond’s last key parliamentary speech and this one, the government (immediately after their paltry re-election result) introduced yet more measures to curb people’s tax free contributions to their pension. They also very kindly backdated these to the April. And this was achieved without a single nay from a politician or any hyperbole in the press headlines.

But why do these allowances matter? And why should you be concerned about the lifetime allowance being reduced to £1 million? Well, while you have probably never considered these limits, now’s the time that I’d love people to sit up and think these things through – and at least before you inadvertently make a horrible mistake.

It’s also a good time because we can probably expect that the government will tinker with pension legislation on 22 November yet again. They’re doing this as they want to reduce the level of tax they forgo as people pay into their pension pots. And while the sums involved lead few to clamour that these are unfair on the average person, I think that it’s precisely these people that could easily be affected if they’ve approached pensions properly.

We calculate that if you were 25 and put £150 in your pension each month, that this amount was matched by your employer, and that you are aiming to achieve a 6% return on your investment, adding anything on top of that could land you in the danger zone. That’s because compounding over all those years until your retirement at the age of 69 takes your total over three quarters of a million quid! It’s not just the amount you put in that works towards the total tally – your investment gains count too.

Breaching the lifetime allowance could lead to a rather stiff tax bill of 55% on any of the money you take out. That’s not a tax bill I’ll warrant anyone expects when they’re retired!

So what are the allowances and what can you do to ensure your money works as hard as you have?

As I write – and the figures may have changed if you’re reading this after the Budget – the lifetime allowance is £1 million, although it should rise with inflation. And the annual allowance is £40,000. However, if you earn over £150,000 per year, that allowance tapers down to just £10,000 as your income increases.

Meanwhile, if you have in any way accessed any of your pension e.g. when you hit 55 you decide to take out money from an old pension pot, you may have officially started to draw on your pension and so then would only be able to pay in £4,000 per annum.

And if the tax limits are again amended (as they well might) you should be conscious of those changes as they could affect you.

And doing something about this could mean you avoid that excessive tax bill, as there are other tax efficient options that you can access to help your investments. So, while you will have paid income tax on the money you put into an ISA, the investment returns can be accessed tax free (albeit within the capital gains tax limits).

Other options exist too, so it is worth getting some specific tax advice (which we cannot offer) as everyone’s individual circumstances are different and so what suits one person may not be suitable for you.

And in the meantime, I suggest that you start to total up any pension pots you have and look at what gains they’ve made, so you can make a plan and seek some help before HMRC comes knocking.

Justin Urquhart Stewart
Co Founder and Head of Corporate Development

Seven Investment Management LLP is authorised and regulated by the Financial Conduct Authority. Member of the London Stock Exchange. Registered office: 55 Bishopsgate, London EC2N 3AS. Registered in England and Wales No. OC378740.

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