When it comes to pensions, it is important that we encourage friends and family members to put money into one sooner rather than later.
And considering the UK’s ageing population, who knows how long our pensions may need to last us?
After all, they’re a great way to save for the future, and savings into a pension are also tax-free while the pot is untouched (before you start taking money from it).
People do seem to be heading in the right direction by putting more money into their pensions- which is good, right?
But as pension wealth is rising quicker, beware- lifetime allowance (LTA) charges could catch you out.
In recent years, HMRC have reported a sharp increase in the number of LTA charges.
Not only that, but the value of these charges has also increased.
You no longer have to be ridiculously wealthy to incur a LTA charge.
So what is the Lifetime Allowance?
Many people haven’t even heard of the Lifetime Allowance
So to explain- the LTA is the amount of money you can take from your pension before the lifetime allowance tax charge applies.
Every time a payout from your pension starts, it is compared against your lifetime allowance to see if any extra tax is to be paid.
If the excess is taken as an income, there will be a lifetime allowance charge of 25%. However, income tax will also be taken from this.
But if it’s taken as a lump sum, it will be taxed at 55%- over HALF.
Since its introduction in 2006, the level of LTA has fluctuated between highs of £1.8Million and more recent lows of £1Million.
It usually increases in line with inflation (in line with the Consumer Prices Index).
The lifetime allowance in the 2020/21 tax year is £1,073,100, and applies to all pensions including:
-All Personal Pensions
-All Workplace Pensions
-Final Salary/Defined Benefit Pensions
-Defined Contribution Pensions
When you reach age 75, your pensions are tested against the LTA- regardless of whether they are untouched or not.
The only pension excluded from the LTA is your State Pension.
You have a pension valued at £1,078,100.
You can draw the first £1,073,100 (Lifetime Allowance) without paying lifetime allowance Tax (some may still be subject to income tax).
However, you will have to pay tax on the excess £5,000 above the Lifetime Allowance.
If you take it as a Lump Sum you would pay £2,750 tax (55%)
If you take it as Income (e.g. Drawdown) you would pay £1,250 (25%) plus income tax.
Am I likely to be affected?
To get more of an idea about whether it may apply to you, try adding up the expected value of your pension payouts.
If you have:
A Defined Contribution Pension– Considers how much money you’ve paid in and how the investment element has performed. This value is checked against your LTA each time you withdraw.
A Defined Benefit/Final Salary Pension- The value that is checked against lifetime allowance is based on multiplying your expected annual pension by 20.
I think I may be at risk of a lifetime allowance charge!
To put it into perspective, if your defined benefit/final salary pension is likely to be £53,655 a year (with no other lump sum), you are at risk of the 2020-21 LTA charge.
If you do have pension funds above the LTA, there are options you can take.
However, it’s probably not best to try it yourself. A financial adviser would be best suited for analysing your situation, wants and needs, and advising you on the best route to take to try and limit charges and protect your LTA.
A few examples are:
If you’d like to read more about how we’ve helped clients with a lifetime allowance problem, view our case study with Ms Miller by following this link:
If you think you may have a lifetime allowance problem and want peace of mind that your pensions are being handled by a professional, simply fill out our contact form which can be found here: