What to consider if you are approaching the limit
If you’ve been diligently saving into a pension throughout your working life, you should be entitled to feel confident about your retirement. But, unfortunately, the best savers sometimes find themselves inadvertently breaching their pension Lifetime Allowance (LTA) and being charged an additional tax that erodes their savings.
If you are a high-income earner or wealthy individual, you could be putting too much into your lifetime pension and risk exceeding the pension LTA.
The government will maintain the pensions LTA at its current level until April 2026, removing the usual annual incremental rises.
The following questions and answers are intended to help you avoid this tax charge.
Q: What is the lifetime allowance?
A: The pension LTA is the limit on how much you can build up in pension benefits over your lifetime while still enjoying the full tax benefits. If you go over the allowance, you’ll generally pay a tax charge on the excess at certain times. By pension benefits, we mean money you receive from your pension in any form, whether that’s a lump sum, a flexible income, an annuity income or through any other method. This allowance applies to your total pension savings, which may be in different pensions.
Q: How much is the lifetime allowance?
A: In the 2022/23 tax year, the LTA is £1,073,100. This allowance has now been frozen until April 2026.
Q: What happens if you exceed the lifetime allowance?
A: Once you have either crystallised your full LTA in pension benefits or on reaching age 75, or death before 75, if earlier, you will be required to pay an additional tax charge on any funds above the LTA.
If you take the funds above the LTA as a lump sum, you’ll pay a tax charge of 55% (and no additional income tax). If you place your excess funds in drawdown or use them to buy an annuity, you’ll pay an upfront tax charge of 25% on the excess funds, and then your normal income tax rate on any income you take.
Q: How is the usage of your lifetime allowance measured?
A: Each time you access your pension benefits (for example, by purchasing an annuity, receiving a lump sum or establishing a flexible income), this is recorded as a ‘benefit crystallisation event’. There can be additional benefit crystallisation events when you turn 75 if you then have uncrystallised funds or funds in drawdown, and on death before 75 if you have any uncrystallised funds (but drawdown funds aren’t looked at again on death).
Q: Is lifetime allowance protection available?
A: Two types of LTA protection are currently available. Individual Protection 2016 requires you to have had total pension savings of more than £1 million on 5 April 2016. It provides you with a personal LTA equal to the value of your benefits on that date, subject to a cap of £1.25m. You can continue pension funding but ongoing funding may be subject to an LTA charge if above your personal LTA.
Fixed Protection 2016 allows anyone who had a pension in place at 5 April 2016 to apply for an LTA of £1.25m but you can’t have had any pension funding after 5 April 2016 and any future funding will cause FP16 to be lost.
Q: Is it possible to avoid the lifetime allowance?
A: If you do not have LTA protection and you are approaching the limit, there are various actions you can consider. These include stopping your contributions (and, instead, investing your money into an alternative tax-efficient environment), changing your investment strategy or starting retirement earlier.
Q: Who does the lifetime allowance affect most?
A: The LTA affects high earners and those approaching retirement age the most, including those with defined benefit pensions. As the value of high earners’ pensions rises over the next four years towards a lifetime limit that will remain fixed, more and more individuals may find they need to stop contributing to avoid breaching the limit.
Q: When should you seek professional advice?
A: The rules around the LTA are very complex and making the right decisions can feel difficult. Receiving professional financial advice will help to identify if you have a problem and offer different solutions to consider, based on a full review of your unique circumstances.
If you have any questions about this article please get in touch via our contact form or if you would like to speak directly to one of our advisors please don’t hesitate to contact Waverton Wealth Director & Chartered Financial Planner, Stephen Hall.