The cuts and adjustments made to the two main pension allowances since 2011 have made retirement planning all the more complex.
The lifetime allowance, which sets an effective tax-efficient ceiling on the total value of pension benefits, was £1,800,000 in 2010/11. Back then, the corresponding annual allowance, which sets an effective tax-efficient ceiling on annual pension contributions, was £255,000.
Dividing the lifetime allowance by the annual allowance suggests it would have taken about seven years of contributions at the rate of the annual allowance to reach the lifetime allowance. In theory at least, you could have deferred pension planning until less than a decade before retirement.
In 2016/17 the lifetime allowance is £1,000,000 while the annual allowance has shrunk to a £40,000 maximum for most people. So now it would take 25 years to reach the maximum, based on dividing the current lifetime allowance of £1 million by the annual allowance of £40,000 – and ignoring any investment growth. The lifetime allowance will start increasing from 2018/19, but only in line with the CPI inflation index. There is no corresponding adjustment planned for the annual allowance.
These two calculations underline how important it has become to start pension planning as soon as practical and keep making contributions each year.
There is scope to carry forward unused annual allowances, but only from the previous three tax years.
For example, you have until 5 April 2017 to mop up any of your unused £50,000 annual allowance for 2013/14. However, you can only take advantage of the carry forward provisions once you have exhausted the current tax year’s allowance.
To complicate matters further, the private sector final salary schemes and HMRC use different valuation bases, so a transfer could push you over the lifetime allowance, even with no fresh contributions.
The constraints now applying to both the lifetime and annual allowance make regular reviews of your retirement strategy all the more important, particularly if you are considering large contributions as the tax year end approaches.