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The pension lifetime allowance – could you breach it?

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Published: 16 Mar 2021

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The pension lifetime allowance is currently £1.0731 million. The experts at Tilney have found that an increasing number of professionals are set to breach this allowance and pay a hefty tax charge when they come to take their pension. In this article, Tilney discuss what to do if you find yourself in this situation.

The allowance is smaller than you think

Having a pension pot of £1.0731 million sounds like a lot, but it isn’t if you think about the total amount of income you will take over the length of your retirement. For example, if you stand to receive £50,000 or more per annum from a defined benefit pension (also known as a final salary pension) and you have other pensions too, then the lifetime allowance could have an impact on you. Members of defined contribution schemes could equally be affected.

So, what can be done?

Continue making pension contributions

Suspending contributions is not normally advisable due to the tax benefits of pension savings. Also, if you are employed, your employer may stop their contributions if you stop making personal contributions. This could leave you worse off than if you were to just pay the tax on the excess.

‘In April 2020, the pension lifetime allowance rose by £18,100 to its current amount of £1.0731 million. Although this was good news, still a number of professionals are in danger of breaching the allowance.’

Bertrand Pole, Pension Specialist, Tilney.

Consider early retirement

If you take benefits from a defined benefit pension before you reach the scheme’s normal retirement age, you could receive a reduced level of income. By doing this, you could reduce the value of your pension enough so that it falls below the lifetime allowance.

If you are a member of a defined contribution scheme, the fund value of your pension is tested against the allowance. By taking the benefits earlier, the fund value will be smaller due to fewer contributions. The value of the pension may never reach lifetime allowance.

Draw the maximum tax-free cash amount

Some defined benefit schemes will pay out a tax-free lump sum. This is in addition to any annual income. You can actually take more tax-free cash up to a certain limit by exchanging part of your pension entitlement. The calculation for this amount is complex and dependent on a number of factors. Seeking professional advice is advisable.

Delay access

The lifetime allowance does not usually apply after you reach 75. If you receive a defined benefit pension at this age, an exceptionally high increase in value would be tested against the lifetime allowance, but this is rare. If by the time you are 75 you haven’t drawn on your pension and it is below the lifetime allowance, you could keep it invested. Your pension is not tested again and its value can go over the allowance, free of any lifetime allowance tax charge.

Use Fixed Protection 2016 or Individual Protection 2016

Fixed Protection 2016 gives you a lifetime allowance of £1.25 million. Eligibility depends on not having made any pension savings since 5 April 2016.

If on 5 April 2016 the value of all of your pensions combined totalled £1 million or more, you could be eligible for Individual Protection 2016. You will receive a personalised lifetime allowance, which is the value of your pension savings as at that date, up to a maximum of £1.25 million.

Already breached the lifetime allowance?

The amount of tax due on the excess depends on whether it is taken as a lump sum or as a pension.  The charges are 55% and 25% respectively.

If taking the excess as a pension, you need to factor in the Income Tax payable too, as pensions are taxed as salary. Overall:

  • Additional-rate taxpayers pay less tax if taking the excess funds as a lump sum rather than as an income
  • Higher-rate taxpayers pay the same amount of tax regardless of whether they take the excess
  • Basic-rate taxpayers pay less tax if taking the excess as a pension.

‘Even if you are in danger of breaching the pension lifetime allowance, the fact that no Income Tax or Capital Gains tax is payable while it is invested means that for many people, it’s still a good idea to carry on making personal contributions.’

Bertrand Pole, Pension Specialist, Tilney.

Tilney can help

If you are concerned about breaching the lifetime allowance or have any questions, Tilney can help. Click here for more information.

They also offer a free initial consultation with a financial planner where you can discuss your individual circumstances and find out more about how they can assist you. Book online now or call them on 020 7189 2400.

The value of an investment may go down as well as up, and you may get back less than you originally invested.

Prevailing tax rates and reliefs depend on your individual circumstances and are subject to change.

This article does not constitute personal advice. If you are unsure as to any course of action, please talk to an adviser.

Issued by Tilney Financial Planning Limited. Authorised and regulated by the Financial Conduct Authority.

About Tilney

Tilney is an award-winning financial planning and investment company that looks after more than £25 billion on behalf of our clients. At Tilney, your personal wealth is our personal responsibility.

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