The earnings sweet spot that makes the most of the ultimate inheritance tax loophole
Pension reforms announced in the March Budget have created a valuable inheritance tax loophole – and now fresh analysis has revealed exactly how to maximise its use.
The Chancellor opened up a valuable opportunity which allows taxpayers to massively reduce their exposure to the divisive 40pc levy when he removed the lifetime cap on pension savings earlier this year.
Pensions are generally excluded from an individual’s estate for tax purposes, so the reform means families can now pass on far bigger sums to future generations tax-free, compared to when the lifetime allowance was capped at £1.07m.
A saver can now build up a £1.9m tax-free retirement pot over 20 years by making the most of their annual pensions savings allowance, which is to be raised to £60,000 a year from April.
But only a small minority will be able to max out their allowance sustainably. The “earnings sweet spot”, according to pension company Aegon, is between £150,000 and £200,000.
Most workers below this threshold will struggle to afford paying £60,000 into their pension each year – even assuming their employer contributes half – while those earning £200,000 or more will start to see their annual allowance eroded.
If a saver’s threshold earnings are above £200,000 and their adjusted earnings (which includes pension contributions) are above £260,000, then their annual allowance is tapered away by £1 for every £2 that their adjusted earnings exceed £260,000.
This means a worker sees their annual allowance halved to £30,000 as soon as their adjusted earnings hit £320,000.
Once their adjusted earnings exceed £360,000, their pensions allowance reduces to £10,000.
The tapering annual allowance can cost top earners hundreds of thousands in pension contributions over their lifetime.
Across a 20-year period, a worker whose contributions are capped at £30,000 would have a pot nearly half the size of a worker who was able to save the full allowance each year.
It means the vast majority of taxpayers – even earners at the very top – will be unable to make the most of the new death tax loophole.
Chris Etherington of tax firm RSM said: “The new £60,000 pension allowance may have sounded like a big Budget giveaway. The reality is that it will only be available to a select few. Many higher earners will have simply shrugged their shoulders at the announcement as they continue to be restricted on how much they can contribute to their pension pot.”
The big winners are those with defined benefit schemes, such as high-earning NHS workers, Mr Etherington said, and business owners who have more control over the level of their personal income.