What is the pension lifetime allowance?
The lifetime allowance is the total amount you can take from all your pension plans without facing a tax charge. It's currently set at £1 million and there’s a common myth that you start to pay the tax as soon as you go over your allowance. In fact, it’s only when you choose to take pension benefits over your lifetime allowance that you begin paying the charge.
The good news is that the limit is inflation linked and could increase from tax year 2018/19.
How does the pension lifetime allowance work?
You pay a tax charge of:
- 55% of any amount you take from your pension savings as a lump sum that is over the lifetime allowance
- 25% of any amount you take from your pension savings as pension income that is over the lifetime allowance
There’s no immediate tax charge once your fund grows beyond the lifetime allowance. You only begin paying a tax charge when you are accessing your pension and the benefits you take exceed £1 million. And it is the benefits over the £1 million threshold which are subject to the tax charge.
Find out if you’re going to reach the limit
Your pension scheme should be able to provide projections as to what your benefits might be worth at retirement.
Careful monitoring may be needed as you approach retirement to work out whether you are likely to breach the limit.
And remember, you will need projections for all your pension pots. If you have a number of pensions, monitoring can be made easier if you consolidate them into a single pot. But it is important that you check before transferring that there are no valuable guarantees that could be lost by moving your pension. There are other considerations and this option may not be right for everyone.
If you are likely to breach your lifetime allowance you have two choices;
1. Stop contributing and save for your retirement outside your pension
If you don’t make regular pension contributions and haven’t yet paid into your pension since 5 April 2016 you may still be eligible to keep the higher lifetime allowance of £1.25M. Fixed protection means an extra £250,000 of you pension fund could be protected from the tax charge but at the cost of being able to carry on funding your pension after 6 April 2016. Remember, the amounts you save for retirement outside your pension will be after income tax and National Insurance.
2. Carry on saving into your pension and pay the tax charge when you take benefits.
You don’t have to stop saving once you hit the lifetime allowance. It simply means that there will be a tax charge designed to recoup the tax relief on the additional funds. This might still be the best place to save for retirement for many people even after paying the tax charge.
4 reasons why exceeding lifetime allowance might not be as bad as you think
Remember that the lifetime allowance is an allowance and not a limit. For some, continuing to pay in and build your pension pot could be the right option.
1. Employer contributions
Stopping paying into your pension could mean you also miss out on valuable employer pension contributions. Workplace pensions typically require the employee to pay a certain level of contributions which the employer will then match. Your employer may not be willing to agree to provide you with some other form of remuneration should you stop funding. So staying in the scheme means you still get to keep some of the contributions your employer is paying on your behalf. And 45% of something is better than nothing at all.
2. Lifetime Allowance to be inflation proofed
The allowance will also increase in line with inflation from April 2018. This means your pension pot may not be over the LTA by as much as you think when you come to take benefits.
3. Control when you pay the charge
If you have a flexible pension, you can control how and when you take money from your pension. You don’t have to take all your tax free cash in one go and face an immediate tax charge. Phasing your income through drawdown means you can delay the point at which the benefits you have taken breach the lifetime allowance.
4. Additional tax benefits of funding a pension
The lifetime allowance tax charge is designed to remove the benefit of the tax relief you have received on those excess contributions. It doesn’t remove the other tax benefits of saving into your pension. Your fund will continue to grow free of UK tax on income and gains — much like an ISA. Pension funds are also typically free of Inheritance tax on death.
The value of investments can go up and down. It’s possible they may be worth less than was invested.
Remember, tax rules and legislation can change and the value of tax benefits depends on your individual circumstances. This information is based on our understanding in December 2016.
Access to impartial guidance
We recommend you seek appropriate guidance or advice before you make any decisions. An adviser may charge a fee for this. You can also get free impartial guidance over the phone or face to face with Pensionwise. Go to pensionwise.gov.uk or call 0800 138 3944. Make sure you understand all your retirement options by reading the Money Advice Service guide – Your pension - it’s time to choose
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