Will the reduced LTA affect you?
Doctors and dentists are fortunate that their hard work in training to become a professional typically provides excess income that allows a comfortable lifestyle and the ability to save for a good retirement.
Subsequently it is common for both doctors and dentists to have a private pension as well any NHS pension also in place.
Retirement planning is a complex area. This article does not constitute advice and we strongly recommend no action be taken prior to receiving advice from a qualified adviser.
Another reduction in the Lifetime Allowance (LTA)
Recently though, news of a further reduction in the LTA, creates a very real problem for many healthcare professionals who have pension funds in excess of £1million.
The LTA is the level a pension pot can grow to within a person’s lifetime, free of tax implications. It applies to both private and NHS pensions. It has been reducing for a while now, first from £1.5 million, to the current level of £1.25 million. From April 2016, the new £1million limit will apply.
Should I stop paying into my pension?
As Independent Financial Advisers to doctors and dentists we have been helping many of our clients with deciding the best route for them when it comes to their continued pension planning.
- Should I give up my employer pension contributions?
- Should I stop paying into my private pension?
- Should I take my employer’s offer of an increase in salary instead of pension contributions?
These are all questions doctors and dentists face at the moment, as they fear paying tax over and above the new LTA.
Have you considered the LTA tax charge may be a price worth paying?
It is only natural to run away from a situation that presents itself with a tax bill.
However, in some circumstances, paying the tax still beats the alternatives, in this case perhaps of reinvestment in savings or property.
Surely, if the financial returns are still greater after the tax has been calculated and paid, you are still winning?
It’s an important and not entirely straightforward decision though, and one that a professional financial adviser can help ease with their experience.
What are the options?
Here are some factors to consider when making the important decision:
Continue funding the pension | Stop funding the pension |
---|---|
POSITIVE 1) Continued benefit of employers contribution, if applicable 2) Continued tax relief at highest rate of income tax for pension contributions 3) Continued growth of tax free investments | POSITIVE 1) Eliminate or reduce the risk of the LTA tax charge 2) Eligible for fixed protection on existing savings |
NEGATIVE 1) On extraction of income above the LTA limit, a 25% tax charge will be applied (55% for lump sums) 2) None of the surplus can be taken as tax free cash | NEGATIVE 1) The employer’s contribution benefit will likely be lost Neutral There will be new decisions to make on where to invest funds |
Employer funding packages = free money
One key influencer is likely to be the level of employer contributions, and whether your employer would stop contributions if you did.
Employer pension contributions are essentially free money so even if a 55% charge applies, that is still a 45% gain! Have you thought of it that way before?
If the employer is not obliged, or choose not, to fund your pension if you don’t contribute too, then it may still be worth paying in your share and taking the hit for the LTA tax charge, just to get their input.
Would your employer offer an alternative like additional salary instead of pension contributions? This isn’t so common with the NHS and public sector posts but can be seen in the private sector.
If yes, be careful to factor in the tax implications, so as to not compare apples and pears. Additional salary will fall subject to income tax and National Insurance so the net effect may in fact work out less than you expect.
Then there is the question of where to invest it if not in a pension. ISA’s? Bonds? Mutual funds? The decision is difficult and would depend on your tax position as a basic rate or higher rate tax-payer when in retirement.
Don’t compare apples and pears! Be sure when considering your options you factor in the tax situation for alternative solutions too!
Protecting your LTA allowance
There will be Protection schemes, likely available for those with pension funds in excess of £1million at April 2016, which will shelter their current pension funds from tax implications so they don’t lose out during this transition. It will effectively mean up to an additional £250,000 would fall as tax-free.
For NHS pensions it gets more complex due to the new 2015 pension as existing pension covers will be lost when joining. This is definitely something to take advice on.
The downside of a protection scheme is that future investment will be restricted. Even a pound of additional funding will see a loss in the protection cover.
Questions that need answering include “how close is your expected date of retirement?” and “how close to £1million is your pension fund?”
Other possible ways to limit the LTA tax charge
Aside from protecting the LTA limit, which comes with it’s own set of considerations, there are some other ways that the LTA tax charge could be avoided, in specific cases.
- Hold on taking pension benefits – the LTA charge only applies on drawdown, so one option would be to wait to see if the LTA limit increases again in future years.
- Draw your NHS pension before April 2016 – if terms and age restrictions allow this could be a possibility. Take care though not to be penalised with reductions from the NHS.
- Transfer some of the pension fund to your spouse – where your spouse has an active role within the practice, a subsequent employer pension contribution could be made
Very careful retirement planning
All in all, this new legislation requires bespoke and more in depth retirement planning as many variables come into play.
When all is said and done though, sticking to the original pension schedule and sucking up the tax bill along with it, shouldn’t be disregarded immediately until a bespoke calculation is prepared for you working through all options and their subsequent tax consequences.
Before you go…
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Dental & Medical Financial Services can help with careful planning to ensure you are taking steps to a happy retirement.
Tel: 01403 780 770