The Lifetime Allowance: a short guide
This content is for information purposes only and should not be taken as financial advice. Every effort has been made to ensure the information is correct and up-to-date at the time of writing. For personalised and regulated advice regarding your situation, please consult an independent financial adviser here at Castlegate in Grantham, Lincolnshire or other local offices.
There is a limit to how much you can save into your pension(s). Yet many people are at risk of unwittingly exceeding this threshold (the “Lifetime Allowance”, or LTA) – leading to a punishing tax bill. In 2021-22, the LTA stands at £1,073,100. This might sound like a lot to some people, but without careful planning it is easier than you might think to end up crossing the threshold.
In this guide, our team at Castlegate (financial planners in Grantham, Lincolnshire) show how the LTA works – offering ideas about how to navigate it effectively with your retirement plan. We hope you find this content helpful. If you want to discuss your own financial plan with us, please get in touch to arrange a no-obligation financial consultation, at our expense:
01476 855 585
info@casfin.co.uk
What is the Lifetime Allowance?
Pensions are amongst the most powerful financial planning tools when it comes to saving for retirement. First of all, any capital growth within this “wrapper” is tax-free. Secondly, with your workplace pension your employer adds their own contributions to your pension under the UK auto enrolment rules (at least 3% of your salary, in 2021-22). Thirdly, the UK government will “top up” your contributions via tax relief – putting the tax you would have paid, instead, straight into your pension according to your income tax bracket (e.g. 40% for the Higher Rate).
Given these generous pension benefits, the government has put rules in place to stop people from abusing the system. The “annual allowance”, for instance, puts a £40,000 limit on how much you can put into your pension(s) each tax year (although unused allowance from the past three tax years can typically be used). The Lifetime Allowance (LTA), moreover, puts a total limit on how much you can save into your pensions – setting aside your State Pension.
How the LTA works
Technically, there is no hard limit on how much you can accumulate in your pension(s). Yet at certain points, “checks” are conducted on the value of your benefits to see if these are keeping with the LTA (£1,073,100). If the checks reveal that you have gone over the LTA, then you may need to pay a tax charge. This is levied at 55% on any excess taken out as a lump sum, or 25% if you keep it within your pension but take an income from it.
Certain “triggers” can lead to checks on your pension benefits. For instance, turning 75 and you have a pension in drawdown – or which you have not touched. Another trigger is taking income from a defined benefit (or “final salary”) pension. After age 75, however, there are typically no more checks on your pension benefits against the LTA.
The LTA and different pension types
With a defined contribution pension (i.e. a pension “pot”) it is usually fairly straightforward to determine whether you are within the LTA. If you have £600,000 saved in a workplace pension by the time you retire, for instance, then there is no immediate danger of exceeding the limit. However, defined benefit pension schemes involve no “pot of money” but rather guarantee a certain annual income in retirement from your previous employer.
Here, you can get an idea of the scheme’s value by multiplying the expected yearly income by 20 (also adding any expected, separate tax-free cash lump sum). For example, if you anticipate getting £20,000 per year from a defined benefit scheme when you retire (with no extra lump sum), then the scheme’s plausible value is £400,000.
Most people have multiple pension pots/schemes under their belts as they approach retirement, however. So, careful planning is needed to make sure that the combined value is within the LTA. Here, a financial planner can be useful to track down all of your schemes and even consolidate them, if necessary (for easier management).
How to keep within the limits
The earlier you plan for retirement, the better. This can help you prepare for the LTA – using a wider range of financial planning tools. For instance, if you are on course to exceed the LTA, you may wish to reduce your pension contributions and put more, instead, into a Lifetime ISA (which lets you generate tax-free returns and has no “lifetime allowance” on how much you can save into it). However, these cannot be opened after age 39 and cannot be contributed to after age 50, with limits on contributions and early withdrawal. Alternatively, a cash ISA or stocks & shares ISA could be considered, benefiting from higher contribution limits and less restrictions on withdrawal of funds.
Another option might be to take your 25% tax-free lump sum from your pension(s) and put this to good use elsewhere – such as paying off your mortgage, clearing expensive personal debts or simply using some of it for pleasure (e.g. a nice holiday). In some cases, it might be possible to apply for protection to “extend” the value of your LTA.
Conclusion & invitation
If you are interested in discussing your own financial plan or investment strategy with us, please get in touch to arrange a no-commitment financial consultation at our expense:
01476 855 585
info@casfin.co.uk
