What is the Pension Lifetime Allowance?

The pension lifetime allowance (pension LTA) is the maximum you’re allowed to receive from your pension arrangements without having to pay a tax charge. If you exceed your lifetime pension allowance, it will be subject to a Lifetime Allowance Charge.

You’re tested against the lifetime allowance when you draw benefits from your pension, or if you die before drawing benefits from the scheme. Such events are known as benefit crystallisation events (BCEs) and involve your benefits being tested against the lifetime allowance.

Reaching Age 75

Furthermore, if you have not taken all of your benefits by age 75, a lifetime allowance test will be carried out at this age on your remaining benefits to ensure you haven’t got savings worth in excess of your LTA.

Tax Implications

Should you exceed the lifetime allowance, any excess funds above this figure will attract a tax charge of 25% if it is withdrawn as an income (e.g. from an annuity or a drawdown arrangement) or 55% if it’s withdrawn as a cash lump sum.

So a higher-rate taxpayer with a pension income of £10,000 per year who had exceeded the lifetime allowance would face their pension income being cut to £7,500 by the lifetime allowance charge.

They would then have to pay income tax at 40% on the £7,500, reducing it further to £4,500. This is effectively the same as the 55% charge that would be levied on a lump sum.

In a defined benefit scheme, your pension plan may agree to pay the tax to HMRC for you and compensate by cutting your annual benefit.

How Much Can I Contribute To A Pension In Total?

The government first introduced the lifetime allowance back in 2006 and was initially set at £1.5m. The pension allowance then rose gradually each year until it reached £1.8m in 2010. From 2010 onwards, however, pension reforms have successively cut the lifetime allowance.

By the start of the 2016/17 tax year, the lifetime allowance had been whittled down to £1m and, from the 2018/19 tax year onwards, rises in line with inflation.

Note that the pension lifetime allowance is different from your annual pension allowance, which refers to how much you can pay into your pension and still receive tax relief in any given tax year. This is currently set at £40,000 or 100% of your earnings, whichever is lower.

Although a £1,055,000 pension lifetime allowance might sound like an enormous sum of money to have in your pension pot, it won’t buy as large a retirement income as you might think based on current annuity rates, especially if you’re looking index-link your income to protect it from inflation in the years to come.

Calculating Your Lifetime Allowance

To find out how much of your lifetime allowance you’ve used, you’ll need to contact your pension provider(s) who should be able to tell you. If you have more than one pension, make sure you tot up what you’ve used in all of the different schemes you belong to.

What counts towards your lifetime allowance depends on the type of pension scheme you have.

Lifetime Allowance and Defined Contribution Pensions

In a defined contribution or money purchase pension scheme, you calculate your lifetime allowance based on the value of your pension pot you’re going to use to fund your retirement.

Lifetime Allowance and Final Salary Pensions

If you have a defined benefit or final salary pension, then the calculation of what counts towards your lifetime allowance is a little more complicated.

Here, you multiply the annual pension due from by 20, and add any tax-free cash lump sum. For example, in the 2019/20 tax year you can receive an annual pension of up to £52,750 before you are hit by the tax charge, as £52,750 multiplied by 20 is £1,055,000 (assuming you take nothing as a cash lump sum),

Warning: The LTA and Leaving a Final Salary Scheme

A final salary pension transfer involves you accepting a lump sum payout to transfer out of a defined benefit pension and into a defined contribution scheme. While this option won’t be right for most people, for the minority of those for whom this is the best path to take there’s a lifetime allowance risk attached.

Final salary pension transfer values, known as cash equivalent transfer values or CETVs, is the amount of money the pension provider is willing to pay you to leave the scheme. Values have been high of late, partly because many schemes have been keen to encourage members to leave due to affordability issues.

However, it’s important that you remember that although a large DB pension transfer value might seem tempting, it could have big implications for your pension lifetime allowance. That’s because, inside a final salary scheme, the proportion of your lifetime allowance you’ve used is calculated as 20 times your annual benefit.

If you leave your defined benefit pension for a CETV worth 30 times your annual benefit (which is something we’ve seen at Drewberry), though, you might find yourself inadvertently over the lifetime allowance and subject to the lifetime allowance charge.

You can use our Final Salary Pension Transfer Calculator if you’re interested in seeing how much your final salary pension scheme could be worth if you transfer out.

Your Options if You’re Approaching the Lifetime Allowance

If you are close to the lifetime allowance or think you could exceed it soon, you should seek professional financial advice to help minimise any tax charges going forward.

You will probably need to stop making contributions, although this can be a difficult decision to make, especially if you receive employer contributions into your pension too.

A pensions adviser will be able to weigh up the various options and help you decide on the best course of action.

Don’t assume you won’t be affected these charges if your pension pot is currently below the allowance.

For example, if your pension pot is currently around £720,000 and you are planning on stopping work in 10 years, even if you make no further contributions then, based on investment returns of 4% a year, it could easily grow to more than the lifetime allowance over this period.

Can I Protect My Lifetime Allowance?

Depending on your individual circumstances, it may be possible to protect your pension benefits above the lifetime allowance.

As of the start of the 2016/17 tax year — the first year of the £1m reduced annual lifetime allowance — there are three protections you can apply to HMRC for if your pension benefits exceed the £1m lifetime allowance on 5 April 2016.

Individual Lifetime Allowance Protection 2016

• Individual protection 2016 protects your lifetime allowance to the lower of either the value of your pension(s) at 5 April 2016 or £1.25m.
• You can’t apply if you already have individual protection in 2014, which protected your lifetime allowance at £1.5m rather than the £1.25m it fell to that year.
• The same is true if you have primary protection, the equivalent offered by HMRC in April 2006 to those with pensions exceeding the newly-introduced lifetime allowance of £1.5m.
• You can continue contributing to your pension(s), but must pay tax on all money taken from your pension(s) that exceed your protected lifetime allowance.

Fixed Lifetime Allowance Protection 2016

• Fixes your lifetime allowance at £1.25m.
• You cannot continue building your pension except in limited circumstances or you’ll lose the protection and pay tax on any pension(s) above the standard lifetime allowance when you take your pension(s).
• You can only apply if you or your employer haven’t added to your pension(s) since 5 April 2016 and you opted out of any workplace schemes by 5 April 2016
• You can apply if you already have individual protection 2014, but the fixed protection 2016 will be dormant until you lose previous protection.
• You can’t apply if you have primary protection or fixed protection from previous years, such as 2014.

Individual Protection 2014

• To be eligible for individual protection 2014, you must have already applied before 5th April 2017.
• Individual protection 2014 protects your lifetime allowance to the lower of either the value of your pension(s) at 5 April 2014 or £1.5m.
• You can continue contributing to your pension(s), but must pay tax on all money taken from your pension(s) that exceed your protected lifetime allowance.
• You can still apply if you already have fixed protection 2014 or fixed protection 2016, but if you have fixed protection 2016 it will become dormant and individual protection 2014 will be opened.
• For all other protections, individual protection 2014 will stay dormant until you lose or give up your previous pension.
• You can’t apply if you have primary protection.

Tax-Efficient Pension Alternatives

If you are close to, or have already exceeded, the lifetime allowance, then you’re likely to want to cease contributions into your pension and look for alternative tax-efficient options.

ISAs or Pensions?

Individual Savings Accounts (ISAs) are one of the best ways to save other than pensions, as returns are free from both income tax and capital gains tax (CGT). From the 2017/18 tax year, you can invest up to £20,000 pa in ISAs, either into stocks and shares or cash, or a combination of the two.

There are thousands of different ISA funds to choose from, so seek advice if you need help building a balanced portfolio which will meet your investment objectives.

If you are particularly risk averse, or only investing over a short-time frame, as cash ISA is likely to be a more suitable choice than stocks and shares. Remember, however, that if you do put savings into a cash ISA, the purchasing power of your money is likely to be eroded by inflation over time.

Venture Capital Trusts and Enterprise Investment Schemes

If you have a strong appetite for risk, then other options you may want to explore include venture capital trusts (VCTs) and enterprise investment schemes (EISs).

VCTs are a type of investment fund similar to an investment trust that invest in very small companies, while EIS helps smaller companies to raise finance by providing tax relief to those who invest in the shares of those companies.

There are significant tax benefits offered to both EIS and VCT investors, but it’s important you understand the risks involved before investing. As these are investments in startup companies, not all of which will survive, you are at risk of losing money. Moreover, these investments can be illiquid and difficult to sell, so may not be suitable for everyone.

Your Financial Plan – Build A Better Future

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