UK Pensions & The Lifetime Allowance – What You Need To Know

Many people aren’t aware of the pension lifetime allowance or don’t think it will ever apply to them. But more and more savers are facing unexpected tax charges in later life – usually those with final salary pensions or who have collected several pensions from different employers. So what do you need to know and how can you make sure you don’t pay more tax than is necessary?

A Tax Charge of up to 55%

The lifetime allowance is the maximum amount of money you can save in your pension over your lifetime. If you breach the allowance there is a tax charge on the excess. You pay 55% tax if you take the money as a lump sum, or 25% (on top of Income Tax) if you take an income.

The Allowance has fallen by £800,000 since 2011

The lifetime allowance is currently £1 million. It has suffered a number of cuts in recent years – falling from £1.8 million in 2011 to £1.5 million in 2012, £1.25 million in 2014 and finally £1 million in 2016. The Government has promised to increase the allowance in line with inflation from 2018, so we hope that there will be no more cuts. However, the cost of pension tax relief has been under scrutiny by politicians for several years and an allowance reduction could help to balance the books – so this may not be set in stone.

More People are being Caught Out

The amount of tax revenue raised from savers breaching the pension lifetime allowance has jumped in recent years as the allowance has fallen. According to the latest Treasury data, the British public paid £47 million of lifetime allowance tax charges in 2011/12 but a whopping £125 million in 2015/16.

When are you tested against the Allowance?

The allowance sounds simple, but how your pension is tested can be complicated. Technically, you are tested against the allowance at every ‘benefit crystallisation event’. There are 13 of these events, including moving part of your pension into income drawdown, buying an annuity, taking tax-free cash and reaching age 75. Some people will only be tested once, but things can get confusing if you take your pension in stages or have several pensions from various jobs. If you trigger one of these events without realising, and you have exceeded the allowance, you will be faced with a surprise tax bill.

It could be Closer than You Think

£1 million can seem like a huge amount to save into your pension, but we have seen growing numbers of people accidentally breach the allowance. Some people have enjoyed excellent growth on their pension investments and have exceeded the allowance without making any new contributions. Many people with final salary (or defined benefit) pensions have also fallen prey to the lifetime allowance because of the calculation that is used to value these pensions.

The Risk of Final Salary Pensions

Final salary pensions are more complicated than defined contribution pensions (such as SIPPs) when it comes to the lifetime allowance. To value a final salary pension, you must first contact your provider to find out how much annual income you are set to receive at retirement. You will then need to multiply this by 20 and add your maximum taxfree cash entitlement. If the final figure is above £1 million, there will be tax to pay.

You can Protect Your Pension

If you are worried about a lifetime allowance tax charge, one option is to protect your pension. This protects your lifetime allowance at a particular value. Currently, there are two main options:

Fixed Protection 2016 – which gives you an allowance of £1.25 million as long as you haven’t made any personal or employer pension contributions since 5 April 2016.

Individual Protection 2016 – if your pension was valued at £1 million or more on 5 April 2016, your allowance will be protected at this value (up to a maximum of £1.25 million). You can continue to make contributions but will pay tax on anything in excess of your protected allowance.

What is the Next Step?

We are able to assist and we will be able to answer any questions you have and advise you on the best way to proceed, in what can be a hugely complex planning area.

Contact us today and one of our experienced advisors will be happy to assist.

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