You could be forgiven for thinking the outlook for pensions is a negative one, not least because of the state of the economy and markets, but also with many high earners continuing to face annual allowance tax charges, involving complex calculations for defined benefit schemes, such as the NHS and Local Government Pension Schemes. Couple this with the current fixed Lifetime Allowance (of £1,073,100) resulting in further potential tax charges, and a rise in the minimum age to access pension benefits set to increase from 55 to 57 (from April 2028), the incentive to invest into pensions may not seem as attractive, as it once did.
That said, pensions remain one of the most tax efficient solutions available on the market and can form a crucial part of financial planning for the future.
In recent years, the tapered annual allowance (where the standard annual allowance of £40,000 is reduced when earnings hit certain thresholds, now over £200,000 a year) has seen many GPs and healthcare professionals retiring early or choosing to opt out of their pension scheme and negotiating an alternative remuneration, rather than suffer an annual allowance tax charge each year.
Research has shown it may have often been in an individual’s best interest to pay the associated tax charge and reap the long term guaranteed benefits in their pension, for just a fraction of the cost to replace these outside of the pension market.
Alternative solutions for tax efficient investments are available but should be considered in addition to pensions rather than instead of. If this is an area you are considering, or you would like to explore what options are available to you, our colleagues from Francis Clark Financial Planning can assist.
The Lifetime Allowance charge
As well as the level of the annual allowance (including implications of the tapered annual allowance, covered above) we have also seen a significant reduction over the years in the pension lifetime allowance (LTA).
The LTA is the maximum pension benefits that can be accrued without an additional tax charge.
The LTA is now somewhat short of the £1,800,000 previously on offer in 2010/2011 and is currently frozen at £1,073,100 until 2025/26 – Given the rate of inflation and the increase in earnings, this threshold effectively reduces each year.
Pension savings are tested against the LTA when pension benefits are taken and on certain other key events including:
- at age 75
- transferring the pension savings to a recognised overseas scheme
- on payment of certain lump sums such as the death benefit
Any excess over the LTA will be subject to a tax charge of either 25% (where taken as an income) or 55% (where taken as a lump sum). For NHS (or other pension scheme members) a charge arising on the drawn down of your pension is deducted from the pension itself over a set period of time. For GPs, this is likely to mean that their charge is actually less than the 25% levied, due to the fact they may well be higher-rate tax payers throughout retirement. This would result in a tax saving of 40% on the 25% charge, meaning the charge overall is just 15%.
The British Medical Association (BMA) has been pushing for NHS staff to have bespoke allowances (both annual and lifetime) for some time as they believe these tax charges are factors in the early retirement of NHS members. They feel Doctors are reluctant to stay in their position and continue to work in an extremely tough environment, as well as helping to clear patient backlogs and waiting lists, if it means suffering an additional tax charge for their pension benefits.
The current state pension of £9,339 is only available from the age of 66 and is set to increase to age 68 by 2044. This is subject to the triple lock which means the state pension rises each year in line with the highest of three possible figures, inflation, average earnings or 2.5%. The triple lock was suspended during the pandemic and has been in the headlines again recently, as each successive prime minister reviews the affordability of maintaining this in light of record-breaking inflation.
There is now a correlation between the increasing state pension age and the minimum age at which an individual can now access their personal pension benefits.
Historically, individuals have had control over their own pension funds from aged 55, but by 2028 this will increase to aged 57 and from then on is set to remain 10 years below state pension age.
The NHS has mirrored this trend increasing the normal retirement age for which you can start receiving benefits without actuarial reductions from age 60 in the 1995 section, increasing to 65 in the 2008 section and the higher of 65 or the state pension age for the 2015 section. Of course, benefits accrued from 1 April 2015 up to 31 March 2022 will be subject to the McCloud remedy and by default will revert back to a member’s legacy (1995 or 2008) scheme. For some, this will be good news and will allow for pension benefits to be taken earlier than anticipated, without actuarial reduction.
It is to be expected that pension members may wish to look to seek alternative ways of investing their surplus capital and structuring their assets, as it is likely these will be needed to provide an income stream to bridge the gap in the early years of retirement, whilst waiting for 2015 section benefits to crystallise (without reduction) and the state pension to be paid.
With so much unsettle in the economy over the last few years, and most recently the market turmoil following delivery of the mini budget, and the subsequent resignation of Liz Truss, it is understandable those looking for alternative solutions may be pessimistic about investments.
Recent headlines have shown a clear focus on macroeconomic trends, surging inflation, rising interest rates and the ongoing concern of a cost-of-living crisis. Recent reports suggest that the UK is likely to already be in recession due to these factors.
Seeing headlines about a recession causes some people to consider divesting their portfolios. However, is it always the case that stock markets go through a downturn during a recession?
The short answer is no, the economy and stock market are different things and may not be as correlated as we would initially expect.
Economies and stock markets aren’t perfectly correlated. There have been several instances where we have seen positive economic growth for a country, yet the relevant stock market has shown negative returns over the same period, and vice versa.
Whilst there is clearly a general correlation between the economy and global market, we can see multiple occasions where the two different measures have moved in opposing directions. The start of the COVID-19 pandemic in 2020 had a clear impact on the global economy, However, the world stock market being heavily influenced by US based technology sectors, together with the sudden turnaround in investor sentiment, delivered a positive figure for the year.
It is in uncertain times like those we find ourselves in now, where the disparity between the economy and market becomes more apparent. In these uncertain times it is vital to ensure any investments are well placed and diversified across regions and asset classes.
In summary, pensions still remain a crucial part of financial planning, and continue to present fantastic opportunities for tax planning. As evidenced above it can be fraught with complexities making advice imperative.
Alternative investments still offer great opportunities for those looking to redirect disposable income, but given the volatility of markets, allowances and legislations it is important to seek financial advice to ensure you are making the right decision for your objectives both now and in the future.
If you think you might be affected by anything raised in this article, or would like to discuss your pension in more detail, please contact your local Francis Clark Contact or a member of Francis Clark Financial Planning for an initial meeting at no cost.