Since UK laws imply a pension lifetime allowance, it is essential to know the amount in your pension and ensure it doesn’t exceed the limit. Otherwise, you could be hit with a hefty tax charge.

Saving for your retirement is as important as keeping an eye on the LTA. Learn about the pension lifetime allowance, consequences if you go over and ways to avoid it.

If you need immediate assistance, don’t hesitate to call our lifetime allowance charge advisors in London on 02087862112.

A lifetime allowance tax charge is the amount payable if the value of your pension exceeds the Lifetime Allowance set by the UK government. Presently, the Lifetime Allowance in the UK is £1,073,100 for 2021/2022.

The LTA is 25% if you draw your pension amount as income or 55% if you take your pension in a lump sum.

The LTA or the limit is applicable to the value of all your pension arrangements, including:

  • Final salary (defined benefit) schemes
  • Personal pensions (defined contribution pensions)
  • Other pension schemes paying a lump sum or income

However, the State pension is not included in LTA law.

The lifetime allowance has been fluctuating over the last couple of years. In recent years, it is increasing with inflation. The LTA for the given year is measured by the consumer price index. The UK Chancellor, in March 2021 announced that the lifetime allowance would be fixed until April 2026.

A lifetime allowance charge is applicable only if the value of your pension savings at a benefit crystallisation event exceeds the lifetime allowance.

For example, if you have pension savings of £2,000,000, you will not be charged right away. However, if you choose to crystallise your entire pension savings, there will be a lifetime allowance charge payable on anything excess of the amount. In this case, the amount is £926,900, meaning £2,000,000 – £1,073,100.

For a defined contribution scheme, the crystallised value is the amount of the fund taken, which is equivalent to 20 x the pension taken + the tax-free cash.

Besides, there is a test conducted against the lifetime allowance when there’s a benefit crystallisation event. The benefit crystallisation events can be of several types, the most common are listed below:

  • Taking benefits
  • Transferring to a QROPS
  • Approaching age 75
  • Demise

In any of the above cases, LTA charges differ and possess individual rules.

LTA tax can be hefty enough to bother your financial plans. Using different techniques, it is possible to avoid the LTA charge. Here are a few tips you can apply:

1. Save in ISAs

Instead of paying your contributions to your pension, use the ISA allowance. You can put up to £20,000 each tax year into use in your ISA. It is called ISA allowance. Hence, you benefit from tax-free investment growth. The funds saved in ISA will not be tested against the pension LTA.

For those on a defined benefit pension scheme, this might not be a suitable strategy. It is wise to stay an active member and keep paying your lifetime allowance.

2. Take early retirement

Consider early retirement from work to avoid the hefty LTA tax charges, especially if you have a confined benefit pension. Several confined pensions allow you to draw your pension amount before reaching your usual retirement age.

However, in this case, your present salary will be considered to determine the amount of the pension. If your income is low, you won’t have to pay LTA tax.

3. Contribute to your spouse’s pension

If your pension is almost approaching your LTA, start saving your contributions to your spouse’s pension. Doing so will keep your money away from tax charges.

But, in case you divorce, all the money deposited from your end will automatically be owned by your partner.

4. Withdraw tax-free cash

Withdraw some tax-free cash from your pension scheme to avoid LTA. By doing so you will leave some funds in your pension to grow and minimise the potential next LTA charge at the recommended retirement age.

The point to be noted here is that any amount withdrawn from the pension scheme will become part of your estate inheritance tax purposes. But the funds in the pension are out of the estate inheritance tax.

Withdraw taxable income

Unlike tax-free cash, withdrawing taxable cash from the pension doesn’t make the pension tested against the LTA. Consider withdrawing your taxable income, which will cost you the higher tax rate of 20%, still less than the 25% LTA tax charge.

The growth on the remaining pension will be subjected to the LTA charges when tested at the age of 75 at the time of your retirement.

Apply LTA protection

There are two types of protection to apply:

1. Individual protection 2016

The individual protection 2016 is applicable if the pension or pensions were valued more than £1m or £1.25m, whichever is the lowest at 5 April 2016.

Your pension will keep growing, but you have to pay the tax on the amount withdrawn from your pensions exceeding your protected lifetime allowance.

You are eligible to apply for Individual protection 2016 through the government’s website, even if you already have previous protection, such as:

  • Enhanced protection
  • Fixed protection
  • Fixed protection 2014
  • Fixed protection 2016

However, you are non-eligible if you already have either primary protection or individual protection 2014.

2. Fixed protection 2016

Fixed protection 2016 will freeze your lifetime allowance at £1.25m. Then, you cannot contribute to your pension anymore.
Still, if you contribute to a pension after you have opted for fixed protection, you will not get the excess, plus you have to pay a tax charge on the excess.

You are eligible to apply for fixed protection 2016 through the government’s website if you:

  • or your employer has not contributed to your pension since 5 April 2016.
  • left out of any workplace schemes by 5 April 2016.
  • already have individual protection 2014.

You are non-eligible to apply if you have enhanced protection, primary protection, fixed protection or fixed protection 2014.

Get Lifetime allowance charge advice in London

Consulting a pension lifetime allowance advisor can provide tangible benefits, with the prospect of significant financial savings in the following ways:

  • Their consultation becomes a necessity as LTA charges are revised periodically and it is possible you are not updated with the latest changes in the charges and rules.
  • The pension provider may choose to apply the tax charge differently based on how you take the excess benefits above your lifetime allowance.
  • Understanding the process is not easy other than the professionals.
  • An LTA advisor can show the right guidance regardless of the situation you are facing. They analyse the situation, calculate the potential exposure and propose specific actions to best optimise your retirement position.

 

Summary

Taking some prudent steps is the best you can do if you do not want to pay hefty tax upon exceeding the specific LTA in the UK. While there are several ways to minimise or avoid LTA tax, as stated above, consulting a financial advisor is the most recommended. You can learn more about escaping paying the LTA tax charge and tips.

Any UK citizen willing to avoid LTA charge must keep checking their pension pool to find out if their pension is exceeding the lifetime allowance. Your pension provider will anyway notify you in writing if that happens.