November 23, 2020
There’s no actual limit on the total pension fund you can save for your retirement. However, the Lifetime Allowance (LTA) is the effective maximum you can save without triggering any tax charges.
The Labour government introduced the LTA in 2006/07. Less than a decade ago it stood at £1.8 million but, since then, successive governments have reduced it so that it now stands at £1,073,100, increasing annually in line with the Consumer Price Index (CPI).
This figure takes into consideration all your pension arrangements – Defined Contribution and Defined Benefit – but not your State Pension.
Pension wealth is increasing at a faster rate than the CPI, so more and more people are having to manage their pension arrangements to negotiate a possible Lifetime Allowance charge. Figures from HMRC, published in September 2019, show a sharp increase in both the number of Lifetime Allowance charges paid, and the total value of those charges.
Paying a Lifetime Allowance is no longer an unusual occurrence or the preserve of the super-wealthy. Here’s what you need to know.
Calculating the value of your pensions
Even though the current LTA figure may sound high, don’t assume that it won’t impact you.
It’s prudent to keep track of your pension plans because you need to consider all of them when working out their combined value. If you have several different plans that you’ve set up over the years this can be a challenge!
Being organised not only makes the job of valuing your pensions easier but could also mean you avoiding an unexpected tax charge if you exceed the LTA without actually realising it.
The two different types of pension arrangements are treated differently for calculation purposes.
Defined Contribution schemes
For Defined Contribution schemes, such as personal pensions, stakeholder pensions, and most employer-sponsored schemes, you need to calculate the overall value of all your pension funds.
You’ll then need to consider how long you may have until you retire, and how much you’re currently contributing into your arrangements.
Looking to the future, if you are in your 50s, then a £750,000 pension fund will exceed £1 million after less than six years if the fund grows at 5% each year – and that doesn’t take into account any regular contributions you may still be making.
Defined Benefit schemes
For Defined Benefit schemes, (sometimes referred to as Final Salary schemes) the overall value is the pension you expect to receive when you retire, multiplied by 20, plus any tax-free lump sum.
Here’s an example. If the scheme you’re in will provide an annual pension of £35,000, together with three times the initial pension as a lump sum, the value you’ll need to consider is:
- 20 x £35,000 = £700,000
- 3 x initial pension as lump sum = £105,000
- Total = £805,000
There is no immediate charge when your overall pension fund grows above the LTA. The charge is only levied when you begin to take pension income over the allowance, and is only calculated at specific times, which are known as Benefit Crystallisation Events (BCE).
These events are typically when you take any income or lump sums from your pension fund, at age 75, and upon death.
If the value of your total pensions exceeds the LTA when the calculation is made, you will pay a tax charge of:
- 25% of any amount over the LTA taken as regular income
- 55% of any amount over the LTA you take as a lump sum.
Lifetime Allowance protection
It is possible to protect your Lifetime Allowance, and therefore avoid the tax charges outlined above. This is especially worth considering if you are already over the Lifetime Allowance limit, or very close to it, and therefore in the position where decent levels of investment growth could easily take you over the limit.
There are several different types of protection you can apply for depending on your circumstances.
You should note that applying for protection will likely mean that you can no longer pay any further contributions into your pensions. This will obviously impact on your financial planning – particularly how you fund your income in retirement.
Protection rules are complicated, and you should speak to a financial adviser before making any decision in this regard.
The LTA in the future
It’s worth remembering that reductions in the LTA have been seen as an easy way for the Treasury to save money for some time. That’s why the LTA is nowhere near the amount it was a decade ago.
With the Covid-19 virus creating a financial crisis, which could easily be exacerbated when the transition period for leaving the EU ends, further reductions to the LTA may be an easy option for the Chancellor.
Planning for retirement
Even with the LTA potentially limiting the amount you can save in pension arrangements, it’s still crucial for you to save for your retirement. Furthermore, it’s still vital to minimise your tax liability as far as possible. It is also important to understand other savings options.
With increasing life expectancy, it may be prudent to build some of your retirement wealth outside of pension arrangements, and hence the limitations of the Lifetime Allowance. For example, you could look at other tax-efficient savings vehicles such as ISAs. The ISA allowance is £20,000 per person in the 2020/21 tax year and it can be beneficial to utilise this as much as possible.
In some circumstances, however, exceeding the Lifetime Allowance may be the best option. If you are still in employment, continuing pension contributions would mean you don’t miss out on valuable employer contributions. Even if this is subject to 25% tax as regular income above LTA, your employer-matched contribution may well exceed this cost over time.
Also, don’t forget that pensions are typically not subject to Inheritance Tax, whereas alternative investments such as ISAs are likely to be.
How we can help
Having a pension approaching or exceeding the Lifetime Allowance doesn’t mean your retirement saving should stop, but there is a real chance the LTA may affect you.
Here at Depledge, we have a team of expert pensions specialists offering bespoke advice. Effective pension planning is complex, but we can help you plan for your retirement in the most tax-efficient way possible.
If you’d like to find out more or would like to talk through your arrangements and how you might be impacted by the LTA, please email email@example.com or call (0161) 8080200.
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The value of your investment (and any income from them) can go down as well as up which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits