Financial planning

Lifetime Allowance: the perils of a big pension pot

Colin Dyer

After hitting a peak of £1.8m (tax year (2011/12), the lifetime allowance for pensions has fallen substantially in recent years. The reduction has led to more people breaching the allowance threshold and incurring a tax penalty. This blog aims to get you thinking about the pension lifetime allowance and how it could affect you. For more information, please contact your 1825 Financial Planner.

 

What is it?

  • It’s a limit on the total value of payouts from your pension plan(s) that can be made without triggering as extra tax charge.
  • Applies to all your pensions, including workplace pensions, but exclude the State Pension and overseas pensions.
  • Whenever you start taking money from your pension, a statement from your scheme should tell you how much of your lifetime allowance you are using up. You will need to keep track to ensure you know how much in total (%) you have used.

How much is the lifetime allowance?

For most people, £1,073,100 for tax year 2020/21, increasing each year with inflation. (The allowance was introduced in 2006. There have been different limits in the years that followed.)

How does entitlement to an increased lifetime allowance work?

Currently the most common way looks to protect pension values of up to £1.25m, from back in April 2016, when the lifetime allowance fell to £1m.

 

Depending on the form of protection selected, there are rules around whether or not you can continue to save into your pension and there could be further tax implications. There may be other ways such as if you qualify for an overseas enhancement for periods when you left the UK. You’ll need to make an application to HMRC for this to become effective.

 

What if I exceed the lifetime allowance?

You’ll face an extra tax charge which will need to be settled before you can take benefits when your total payouts exceed your limit. The charge will be:
  • 55% on any amount over your lifetime allowance that you take as a lump sum, or
  • 25%on any amount over your lifetime allowance that you take as regular income. This is on top of income tax at your marginal rate.
You only pay this when you take money out of your pension, or as a result of breaching the allowance at the ‘age 75 test’ (see below).

Should I stop saving into my pension plans?

If you have exceeded your lifetime allowance, the temptation may be to stop funding your pension so that you don’t incur additional tax.
But it may not be the right thing to do.

Your pension could still be the best place to save. For example, if you keep paying into a workplace pension, you’ll still benefit from tax relief as well as continuing to get any employer contributions. And don’t forget, the lifetime allowance will rise with inflation.

Your 1825 Planner will be able to help you decide on the best course of action.

The age 75 - what happens at ages 75?

On reaching age 75, any untouched pensions savings and any drawdown funds over the original amount invested will be tested against your remaining lifetime allowance. You may be liable to an extra tax charge, at 25%, if you exceed your lifetime allowance at this time.

Who should be concerned?

  • People nearing retirement, who’ve gathered a few different pensions along the way and not absolutely clear on the total value of their pensions.
  • Anyone with final salary pension schemes.
  • For those who maybe need to take action before the ‘age 75 test’.

This is a complex area and advice is recommended. Please speak to your 1825 Financial Planner if you want to discuss the Pension Lifetime Allowance.

Remember, tax rules and legislation can change and the value of tax benefits depends on your individual circumstances. The value of investments can go down as well as up, and could be worth less than what was paid in.
The information in this blog or any response to comments should not be regarded as financial advice. Information correct as at April 2020.