What is the pension lifetime allowance
Pensions are a tax-efficient way to save for your retirement because your pension contributions aren’t taxed, and they aren’t subject to tax while they’re in your pension pot. However, there is an upper limit, beyond which you will pay tax on the benefits you draw from your pensions. It’s called the Pension Lifetime Allowance. Most of us won’t be affected by it, however, if your pension pot is approaching £1m, it’s worth being aware of it and planning accordingly.
How much is the Pension Lifetime Allowance?
Since 6th April 2020, the Pension Lifetime Allowance has been £1,073,100 and will be frozen at this amount until 2025/26 tax year. However it is likely to rise after this date, in line with inflation. What that means is that you can make withdrawals from your personal pension/s during your retirement, up to that limit without having to pay the Lifetime Allowance. Your state pension and overseas pensions do not count towards the amount.
It may sound like a big figure but pensions are long-term investments and can mount up to considerable sums over a standard lifetime. However, those with large pension pots should be aware of this potential tax charge and keep an eye on the level of your savings.
How does the Pension Lifetime Allowance work?
The Pension Lifetime allowance is worked out slightly differently depending on what kind of pension you have.
- Defined Contribution pensions - the value of your benefits is the total value of your pension pot in your defined contribution scheme.
- Defined Benefits pensions - if you’re a member of a defined benefits scheme, also known as a final salary scheme, you can work out the value of your benefits by multiplying the annual pension you expect to get by 20 and adding any tax free cash that you received.
What are the charges?
The tax charge that’s due if you exceed your lifetime allowance depends on how you’ve taken your benefits.
- Lump sum – if you take your benefits as a lump sum you will pay a tax charge of 55% on the amount.
- Income – the tax charge is 25% of the amount of money from your pension that you’ve taken as a retirement income. For example, if you took it as a scheme pension, for buying an annuity or via drawdown. You’ll also pay income tax on this amount.
Here’s some examples of how that would work:
Protecting my lifetime allowance
The Lifetime Allowance was introduced in 2006 and has been reduced over the following years. However, you can apply to protect the value of benefits you may have built up (and any future benefits) from tax charges.
If your total pension savings were more than £1 million on 5 April 2016 you can choose from two schemes, Individual Protection 2016 and Fixed Protection 2016.
What happens if I get divorced?
If the pension has been split as part of a pension sharing order, you and your ex-spouse or ex-civil partner will each receive a new personal allowance entitlement. This counts towards your individual Lifetime Allowance limits.
If the pension is part of an earmarking or attachment order, the whole pension entitlement counts towards the member’s Lifetime Allowance.
What if I have more than one pension?
If you are a member of several pension schemes you’ll need to add together all the amounts that you use from these to calculate whether the total amount means you will pay the Lifetime Allowance charge.
Talk to an FCA-registered financial adviser
If you think your personal pensions might exceed your Pension Lifetime Allowance it may be worth talking to an Independent Financial Adviser about your options. You will be charged a fee for their financial planning advice, however it could help you either avoid paying a tax charge or reduce the amount of tax you would need to pay.
The Pension Lifetime Allowance is something most people aren’t aware of. So it’s good to be informed. Now find out how to boost your pension income.
The information on this page was sourced between June - October 2020 and updated in April 2021. Information on this site does not constitute any form of advice, representation, or arrangement by us and you take full responsibility for making (or refraining from making) any specific investment or other decisions. You should take independent financial advice from an adviser who is registered by the Financial Conduct Authority.