Lifetime Allowance in the UK affects thousands of pension savers each year. With a headline tax rate of 55%, financial planning is important to understand your position and to mitigate the impact of any possible tax charge.
It is a tax charge that rarely makes news headlines. Although from the latest UK government statistics, the average charge for those affected was £40,659.
Since 2016, the number of pension savers who have been affected by the Lifetime Allowance has increased markedly, as we show in the sections below. In the spring budget of 2021, it was announced by the chancellor that the Lifetime Allowance will not increase and will instead remain frozen at the current level of £1,073,100 until 2026.
Broadly speaking, if your pension assets are valued in excess of £500,000 or you are aggressively funding your pension there may be a realistic prospect that you may be affected by this issue during your lifetime even after benefits have been taken initially.
What is the Lifetime Allowance? How are you affected by it? What can you do about it?
Below, we take you through some of the most common questions we are asked by clients relating to the Lifetime Allowance and what options you may have to reduce the impact.
How am I affected by the Lifetime Allowance? What can I do about it? Is it worth still paying into a pension when I’ve already reached the Lifetime Allowance?
We also discuss how the Lifetime Allowance charge is calculated; along with different examples outlining how clients may be affected.
Lifetime Allowance common questions:
The Lifetime Allowance (LTA) is the total amount that an individual can build up in all of their pensions, without incurring a tax charge. The Allowance is currently set at £1,073,100 for 2021/ 22.
The LTA was introduced by the UK government in 2006; it was initially set at £1.5m, although the level has changed several times since.
If pension assets and entitlements are deemed to be in excess of the lifetime allowance when benefits are taken, then a tax charge will be levied on the surplus at 55% of the excess if taken as a lump-sum; or 25% if taken as income (which will then also be taxed at marginal rates as income in addition when benefits are taken).
The tax charge can be triggered in a number of ways including:
• taking income from your pension or pensions
• taking lump-sums from your pension
• transferring your pension overseas
• simply reaching age 75; even if you haven’t accessed your pension(s)
• on the event of your death
In the Lifetime Allowance rules, these trigger points listed above are called ‘Benefit Crystallisation Events’. We go on to explain these in more detail in the sections below.
This of course depends of your circumstances. However, one of the first things to be aware of are the forms of Lifetime Allowance Protection available to protect savers affected by the changes to LTA for a limited amount of time.
• 2016 – Fixed Protection
If the value of your pension assets was below £1m at 5th April 2016, Fixed Protection 2016 will preserve a lifetime allowance of £1.25m for those who successfully apply for it. In order to maintain Fixed Protection 2016 all future pension contributions would have to cease and no future accrual would be permissible in defined benefit (final salary) schemes.
• 2016 – Individual Protection
For those with funds/ benefits in excess of £1m at 5th April 2016, the value at this date will be protected up to £1.25m. Future accrual and ongoing contributions may continue.
• 2014 – Fixed Protection
It may be possible to preserve funds or benefits of up to £1.5m under a previous transitional protection arrangement from 2014 when the lifetime allowance reduced from £1.5m to £1.25m depending upon your circumstances. Similar to 2016 Fixed Protection, no further accrual or funding is permissible.
• 2014 – Individual Protection
For those with funds/benefits in excess of £1.25 million as at 5th April 2014. The lifetime allowance remains at this value, subject to a maximum of £1.5 million. Future accrual and ongoing contributions may continue.
• 2012 – Fixed Protection
For individuals who expect the value of pension savings to exceed £1.5 million in funds/ benefits when they retire. An individual who has claimed fixed protection 2012 will not incur a lifetime allowance charge on any of his benefits up to £1.8 million, similar to 2016 Fixed Protection, no further accrual or funding is permissible.
• Enhanced Protection
This was introduced in 2006 for anyone who was over or could be over £1.5m in benefits. There is no limit to the fund value that a pension can increase to. No lifetime allowance charge will occur providing, in most cases, no further contributions (defined benefit accrual within certain limits) are made into a pension scheme.
• Primary Protection
This was introduced in 2006 for anyone with over £1.5m in benefits who wanted to continue contributing into their pension. They were given their own lifetime allowance based on their fund value at 6 April 2006. For example, someone who had £1.8m in pension assets would have had a lifetime allowance of 120% (i.e. £1.8m ÷ £1.5m = 120%).
• Other Points to note
If pension funding is approaching the stage where the lifetime allowance is a threat to the tax-efficiency of your retirement plans, consider funding plans on behalf of a spouse as an alternative.
Caution should be exercised if previous steps have been taken to address the lifetime allowance in the past. For example, primary or enhanced protection.
For those that are affected by the Lifetime Allowance, there can be significant charges involved after breaching the limit.
If you believe that you may be affected by the LTA and would like further advice on how best to approach the subject, please get in touch for a confidential consultation. Broadly speaking, if your pension assets are valued in excess of £500,000 or you are aggressively funding your pension there may be a realistic prospect that you may be affected by this issue during your lifetime even after benefits have been taken initially. With a headline tax rate of 55%, financial planning advice will be worthwhile.
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The pension Lifetime Allowance limit for individuals in the UK, has changed significantly since it was introduced in 2006.
2006/07 – £1,500,000
2007/08 – £1,600,000
2008/09 – £1,650,000
2009/10 – £1,750,000
2010/11 – £1,800,000
2011/12 – £1,800,000
2012/13 – £1,500,000
2013/14 – £1,500,000
2014/15 – £1,250,000
2015/16 – £1,250,000
2016/17 – £1,000,000
2017/18 – £1,000,000
2018/19 – £1,030,000
2019/20 – £1,055,000
2020/21 – £1,073,100
2021/22 – £1,073,100
From April 2018 the LTA was indexed to increase each year in line with inflation, or more specifically the increase in CPI. Therefore it was due to increase gradually over time. And so from 2018-2021, the lifetime allowance was:
2018/19: the limit was £1,030,000
2019/20: £1,055,000; and
However, it was announced by chancellor Rishi Sunak in March 2021, that the Lifetime Allowance would be maintained at £1,073,100 until April 2026. This was seen as a step to increase the governments tax takings following the massively increased spending through the Covid pandemic. Whichever side of the political fence you are on, the continued tinkering will be understandably frustrating to those higher earners who are or may now be affected.
It may be that you are already in excess of the LTA or that you are on course to be in excess of the limit.
However, that doesn’t necessarily mean that continued pension contributions no longer represent good value. For example, if your employer made contributions to your pension without you making any personal contributions.
Clearly, your current personal and financial arrangements will dictate which options will be open to you and what the best course of action is. Speaking to an Independent Financial Adviser is often a good first step.
The LTA applies to both defined contribution (DC) and defined benefit (DB) pension schemes, with the benefits valued in the following way:
*For example, if your Defined Contribution pension is valued at £150,000 then this is the amount which is used when testing against the LTA.
**If your annual pension is £5,000 then, when multiplied by 20, this provides a value of £100,000 which is the amount which is used to test against the LTA
Pensions in Payment before 6 April 2006
The calculations for Lifetime Allowance differ if you have a pension that was in payment before the 6th April 2006. This adds some complexity for understanding:
- What your Lifetime Allowance is
- How much of it you have used – and therefore, will you receive a tax charge
As we mentioned above, the tax charge can be triggered in a number of ways. These are called ‘Benefit Crystallisation Events’ (BCE) and include:
• when taking income from your pension or pensions
• taking lump-sums from your pension
• transferring your pension overseas
• simply reaching age 75; even if you haven’t accessed your pensions
• on the event of your death
One of the main differences for pensions in payment prior to April 2006, is that typically those pensions are valued at 25 times the yearly pension, depending on the type of pension. For example:
|Types of Pension||How they are valued in LTA calculations|
|Lifetime Annuities & Scheme Pensions||25 times the yearly pension on the first day the first Benefit Crystallisation Event (BCE) occurs|
First BCE before 06/04/2015
|25 times the maximum yearly income allowed under capped drawdown on the first day the first BCE occurs|
First BCE after 05/04/2015
|25 times 80% of the maximum yearly income allowed under capped drawdown on the first day that BCE occurs|
To speak to an adviser regarding Lifetime Allowance planning, or retirement planning more generally, contact us for a free face to face or online consultation:
- Planning your retirement
- Can I afford to retire?
- High earners falling foul of the Personal & Annual Allowance Taper
- Inheritance and Estate Planning
- Making the most of your investments
- Pension Advice Glasgow
- Also, further reading on the .gov.uk website
Find more opinion on our blog: https://www.glasgowwealth.co.uk/glasgow-wealth-profile/