In the three years since 2012 the Government has virtually halved the sum people can save into pensions during the course of a working life, slashing it back from £1.8m to £1m.
The numbers may sound big: but the retirement incomes such sums can buy is disappointing.
The latest cut – announced on Wednesday in the Budget – takes the lifetime limit down from £1.25m to £1m.
If your pension grows above that, the tax payable when money is subsequently withdrawn is 55pc.
The Government has decided the limit will remain at £1m until 2018, before increasing in line with inflation every year thereafter. This is not much of a sweetener. The new limit will place a restrictive ceiling on the retirement incomes of middle-class workers such as doctors, middle-managers, teachers and policemen.
Many will now need to change their financial plans. And even though the Budget ink is barely dry, financial advisers have already posted thousands of letters to clients aged 50 and over, warning them at what date they are expected to break through the new lifetime allowance.
One such letter is likely to be opened by John, a 50-year old company director with a £500,000 pension fund. John has £1,000 going into his pension each month and is aiming to retire on his 65th birthday. When he opens the letter from his adviser, Tilney Bestinvest, he will learn that if his pension fund continues to grow at 7pc a year, he will reach the new £1m allowance when he is 58.
Another saver about to receive a shock in the post is Alison, a 55-year-old solicitor with an £800,000 pension pot. She no longer contributes to her pension – because she is already aware of the danger of exceeding the limit – yet she too wants to work until her 65th birthday. Alison will soon find out that if her cautiously invested portfolio continues to grow at 4pc, she will exceed £1m before her 60th birthday, leaving her potentially liable to a huge tax bill.
The lower ceiling is also a blow for younger savers. As things now stand those in their 40s and 30s will not be able to amass retirement funds as generous as their parents’.
The Pensions Minister, Steve Webb MP, has recently warned that people in their twenties and thirties need to be contributing 15pc of their salary into a pension to have a “comfortable” retirement - around seven times more than most currently save. But following the Budget announcement his advice is now questionable.
If a 25-year-old saver earning an average graduate salary of £30,000 put 15pc of their salary into a pension, they would exceed the £1m threshold before they retire, according to projections from Mercer, a pension consultant.
Final salary? You'll get off more lightly
The cut will hit savers with defined contribution pensions twice as hard as those with final salary arrangements in place. This is because they are calculated in very different ways.As a Canadian reading all these pension articles from the UK makes me glad I don't live there. What a needlessly complicated pension system.
For someone using a defined contribution pension pot to buy an index-linked annuity with a spouse’s pension, the allowance cut takes the maximum annual income you can buy down from around £33,500 (bought with a £1.25m fund) to just under £27,000 (bought with a £1m fund). That assumes you take no tax-free cash and spend every penny on an annuity.
For people with final salary pensions, the maximum annual pension they can receive if their pension is worth under £1m in total is reduced to £50,000, down from £62,500 for a fund worth £1.25m.
This higher benefit arises because the value of a final salary scheme – for the purposes of working out the lifetime allowance – is found by multiplying the annual benefit by 20.
Brian Henderson, a partner at consultants Mercer, said: “On the face of it, £1 million is a huge amount of money and beyond the reach of many. However, the impact of this reduction on defined contribution savers reminds us that they continue to be the poorer relation when it comes to pension provision.”
He predicts that some savers will have to abandon the idea of further pension savings and turn instead to “making use of the increased Isa allowances, which they may sensibly choose to use as an alternative to pension savings.”
What should I do if my pension is nearly worth £1m now?
That depends on your age, on how long you have until you want to draw benefits, and whether you want to keep investing.
The new limit doesn’t apply until April 2016 so you have some time to prepare. But if you are near the limit, you do need to keep a close eye on your fund value.
You have the option to “protect” the higher limit of £1.25m if you apply to do so before April 2016 (read on for more details).
So some investors will have to weigh up the advantages of further tax relief if they continue to contribute, against the risk of becoming liable to the penal tax. You will want to get as close as possible to the cap – without ever exceeding it.
This is why your age matters very much. By taking money out of your pension you can manage the risk, but you can only make withdrawals if you are over 55.
Once the money is outside of the pension, if it grows, this growth won’t count toward your allowance. But your withdrawals won’t give you new “headroom”. That’s because the limit is calculated at the point of any withdrawal. So drawing £200,000 from a £900,000 pension will still leave you a lifetime balance of £900,000.
Every time you take benefits, including your tax free cash, your pension firm will test your fund against the lifetime allowance and report this information back to HMRC. If you don’t make withdrawals, your pension firm will only test your pension against the limit at age 75, and/or when you die.
Jackie Holmes, a senior consultant at Towers Watson, said that although the 55pc tax which applies where the limit is exceeded is punitive, sometimes it is better just to pay the tax than to give up valuable benefits.
Some employers offer cash alternatives to pensions for people who have already reached the lifetime allowance, but for people in final schemes these rarely get close to the value of the pension that must be given up.
She said: “ If your employer isn’t offering a cash alternative at all, it’s better to pay 55pc tax on something than 0pc tax on nothing – though the decision is less straightforward if the employee must contribute to benefit.”
What should I do if my pension is worth between £1m and £1.25m now?
If you’ve already built up a pension worth more than £1m but less than the old limit of £1.25m, you’ll be able to “protect” your pension at its current value under various arrangements. Using “protection” means no more money can be put into your pension, or the protection is lost. One danger is where employers mistakenly pay into a pension where protection has been set up, potentially leaving savers vulnerable to the 55pc. The Government knows this is a problem for high earners and has introduced a new rule to allow you to ask your employer to permanently exclude you from “auto-enrolment” into a scheme.
The other thing I don't really buy with this article is that people in Britain are actually able to save £1m or more by the time they hit 55 years of age. People in the UK are being squeezed by higher cost of living and high taxes. I have serious doubts that they're tucking away 15% of their income for their retirement.
Sure, the Chancellor, George Osborne, just announced plans for a "savings revolution" as the centerpiece for his final budget, just 50 days before the election, but this won't help the working poor as much as the Conservatives claim:
“This Budget helps hard-working people keep more of the money they have earned,” Mr Osborne said.A lot of things can happen between now and 2018, derailing those "sweeping tax cuts" the Conservatives are promising. All it takes is another global financial crisis or a major euro crisis and you can throw those government projections right out the window.
“This is a Budget that takes Britain one more big step on the road from austerity to prosperity. We have a plan that is working – and this is a Budget that works for you.”
In a surprise announcement, Mr Osborne was also able to proclaim that government debts - as a proportion of the total size of the economy - are forecast to begin falling this year.
The austerity programme will also end a year earlier than expected in 2018 - paving the way for the Conservatives to offer sweeping tax cuts if they are re-elected in the forthcoming general election. New tax pledges are expected to be included in the party's election manifesto next month.
And by the way, those in a defined-contribution plan are much more vulnerable to the vagaries of markets than those in defined-benefit plans. That's just part of the brutal truth on DC plans. This is why I'm totally against taking money out of pension plans unless you face serious financial constraints due to health or other unfortunate events.
What else? As Katie Morley reports in an other Telegraph article, hundreds of thousands of UK pensioners living overseas are discovering that their state pension is at risk of being cut off if they “fail to prove they are alive”:
Since 2013 the Department for Work & Pensions (DWP) has been making expat pensioners fill in official forms to stop their friends and relatives fraudulently claiming their state pensions after they have died.Well, I'm all for anti-fraud measures when it comes to pensions and social programs but they better make sure these people are really dead or they risk making some serious mistakes like they did in the United States.
If forms are not correctly filled out and returned within nine months, the DWP will assume pensioners are dead – and will stop their pension payments.
Below, CBS 60 Minutes reports on how thousands of errors to the Social Security Administration's Death Master File can result in fraudulent payments -- costing taxpayers billions -- and identity headaches. Watch this report, it's another eye-opener.
Unfortunately, 60 Minutes doesn't always get it right, like Sunday night's report on rare earths and China. Be very careful deducing any investment advice from 60 Minutes and other news outlets.