Savings

How much will the new pension savings tax raid cost you?

A new raid on retirement savings will mean two million savers will now face tax charges of up to 55% on their retirement funds, an analysis has found.

The lifetime retirement allowance is a cap on the amount of money you can save for your retirement without having to pay tax.

The threshold is currently frozen at just over £1million until 2026, meaning more workers will be hit by the charge as inflation drives their savings above the limit . Now a new two-year freeze is supposedly being considered by the Treasury.

Analysis by consultancy LCP suggests that before the first freeze, around 1.2 million savers were at risk of not meeting the allowance. The five-year freeze has put around 500,000 more people at risk, and a further two-year freeze would bring the total at risk to two million, the LCP estimates.

All savers benefit tax reduction on pension contributionsbut when the total value of the retirement savings exceeds the allowance, they must in fact repay the tax relief they received.

The lifetime allowance is currently set at £1,073,100, and any savings over this limit are taxed at 55% if the money is taken as a lump sum, or 25% plus your income tax rate if it is phased out. This means that £100,000 of savings above the threshold withdrawn immediately would result in a tax bill of £55,000.

Retirement pots intact that exceed the lifetime allowance are taxed at 25pc above the threshold at the saver’s 75th birthday.

When introduced in 2006, the allocation was £1.5 million. It was increased to £1.8 million in 2010, reduced to £1.5 million, then reduced to £1.25 million and finally to £1 million in 2016. It increased with inflation until 2021, when it was frozen by Chancellor Rishi Sunak at its current level for five years. Estimates at the time suggested the freeze would add £990m to the Treasury, with inflation pushing more savers above the allowance.

If new Chancellor Jeremy Hunt were to extend this freeze for another two years until 2028, it would leave pensioners paying an additional £400million in tax, according to analysis by wealth management firm Quilter.

In total, the now seven-year freeze on the lifetime allowance could net the government £1.4billion.

But while an increasing number of savers will be drawn into paying the tax burden, former civil servants are better protected from the penalties stemming from the lifetime allowance. Indeed, for savers in defined contribution pensions, the limit applies to the value of your pot invested.

However, for members of public sector schemes, the value is usually calculated by multiplying their expected annual pension by 20.

This means that a retired public sector worker can have a pension income of £53,655 without hitting the cap, while a private sector worker with a pension at the cap would receive an income of £45,740 if he was buying an annuity at current rates, according to analysis by the Retirement Planning Project, a financial advisory firm.

The firm’s William Burrows said: ‘Lifetime allowance can be fiendishly complicated. There’s very little that can be done to mitigate overtaxing, so most people have to smile and bear it.