A lifetime allowance limits the total value of benefits that you are allowed to take from all your pension arrangements before you can pay all the additional taxes. 

This value is set to limit the total amount you are allowed to build before your retirement as you retain your full tax benefits. The Government imposes the lifetime allowance tax every tax year.

Currently, the LTA for the year 2021/2022 is £1,073,100. Since the LTA is normally high, it is not likely to affect most people. In case you have several pots and you think you are going beyond the set lifetime allowance, there is a lot you can do to avoid the tax charge. 

You can start by calculating your lifetime allowance tax and finding out if you are on the right track.

The lifetime allowance limit applies to the total value of your pension arrangements. This includes:

– All your defined contribution pensions (Personal Pensions)

– Your final salary schemes (Defined Benefit)

– Any pension that has paid you some income or a lump sum

Calculating the Lifetime Allowance 

Suppose you are on a pension that you started withdrawing on 6th April 2006. In that case, you can calculate the capital value of the pension benefit by simply multiplying the annual pension by 20 then adding the lump sum you have drawn from your pension scheme.

The capital values of your benefits are usually expressed as a percentage of the lifetime allowance limit every time you make a payment of a pension benefit. Therefore, you should record all your pensions, even when they are small and not likely to be more than the LTA.

Get advice from lifetime allowance planner for help on calculating your lifetime allowance and UFPLS.

Lifetime Allowance Test 

If you reach 75 and you still have some unused pension benefits, or you simply have some pension funds in the drawdown, the HMRC will test your pension automatically against the lifetime allowance.  

If the test shows that you have exceeded the set lifetime allowance, you will have to pay a tax charge. The tax charge is usually 25% of any pension income and 55% of any lump sum.

This same test still applies when you die before attaining 75 years. Suppose you die before you’re 75, your beneficiaries can simply decide how they would like to draw the pension money. The option they pick will always determine the rate of tax charge payable. The beneficiaries will be responsible for paying this charge to the HMRC.

What is Tested in the Lifetime Allowance?

On your 75th birthday, the HMRC will test if you qualify for the LTA. What is tested includes the total amount you are accessing. That includes what is paid to you and the income or lump sum. This uses a percentage of your lifetime allowance.

The pension that was previously moved to the drawdown and any other untouched pensions are also included when the test is done at 75.

Final Thoughts 

You must monitor the value of your pension if you want to avoid the lifetime allowance charge. Keep monitoring your pensions, especially if there is an increase in the value of defined benefits. 

You can also consider applying for protection if you expect your savings to exceed the set lifetime allowance threshold. Such protections include the Individual Protection 2016 and Fixed Protection 2016. You can check with the HMRC if you have already applied for any of this protection. 

Lastly, you can reach out to a chartered financial planner such as Walpole for more advice on lifetime allowance charges and avoidance.