What Is The Pension Lifetime Allowance?

How Much Can I Pay Into My Pension?

The pension LTA shouldn’t be confused with the annual allowance. The annual allowance refers to the amount you can invest into your pension in a single year and still receive tax relief.

Until recently, this was set at £40,000 or 100% of your earnings, whichever is lower. As of the 2023/2024 tax year, the annual allowance is increasing to £60,000. This means that in a given year, you cannot save more than this sum into your pension.

The lifetime allowance is the total amount you can draw as pension over your lifetime. The UK government first introduced the LTA back in 2006, initially at £1.5m. Any pension savings that exceed the LTA are subject to the Lifetime Allowance Charge.

Over time, the lifetime pension allowance has changed in line with policy and inflation. The table below illustrates the previous thresholds.

A pension pot of £1,073,100 sounds like an enormous sum of money. But sadly, it won’t buy as large a retirement income as you might think based on current annuity rates.

This is especially true if you’re looking to index-link your income. Linking your income to the inflation index is an effective way to protect your pension pot from losing value in years to come.

The LTA has remained at £1,073,100 since the 2020/2021 financial year. It was due to be frozen until the 2025/2026 financial year. However, in the Spring budget 2023, the chancellor announced the abolition of the LTA.

How To Calculate Your Lifetime Allowance

To find out how much of your lifetime allowance you’ve used, you’ll need to contact your pension provider(s), or speak to a financial adviser. If you have several pensions, make sure you add up what you have in all your different schemes.

The funds that count towards your lifetime allowance depend on the type of pensions you have. There are typically two different kinds of pension schemes you might have.

Defined Contribution Pensions

A defined contribution (DC) pension scheme is also known as a money purchase pension. They are called this because you regularly contribute a defined amount towards your retirement.

These are the most common schemes offered by employers. But you can also start defined contribution personal pensions with your provider of choice.

With a defined contribution pension scheme, you calculate your LTA based on the total value of the pension pots that will fund your retirement. When you draw your pension, you can take the first 25% as a tax-free lump sum. HMRC will tax the remainder just like any other income.

Final Salary Pensions

With a defined benefit (DB) or final salary pension, your employer pays you a pension based on your final salary at retirement. If you have this kind of scheme, the calculation of your LTA will be a little more complicated.

To calculate your LTA, you multiply the annual pension by 20, and add any tax-free lump sum. For example, in the 2019/20 tax year, you could receive an annual pension of up to £52,750 before being subject to the lifetime allowance tax charge. £52,750 multiplied by 20 gives you £1,055,000, assuming you take no cash lump sum.

A defined benefit, or final salary pension scheme, is only available as a workplace pension. They’ve declined over time, with very few employers offering them nowadays due to the high cost.

Warning: Leaving A Defined Benefit Scheme

In some cases, you might undertake a final salary pension transfer. This involves you accepting a lump sum payout to transfer from a defined benefit pension to a defined contribution scheme.

While a transfer won’t be right for many people, there’s a risk attached for those who do take up this option.

The lump sum your pension provider is willing to pay is known as the cash equivalent transfer value or CETVs. These values are often high, partly because many schemes have been keen to encourage members to leave. This is often due to affordability issues with defined benefit pensions.

Even though a large payout might seem tempting, it could have big implications for your LTA.

Inside a final salary scheme, your LTA is calculated as 20 times your annual benefit. So, if you take a payout of 30 times your annual benefit, you could exceed the LTA. You’ll then have to pay the lifetime allowance charge.

Andrew Southgate
Senior Financial Planner

To help you navigate this tricky tax area, we have a Final Salary Pension Transfer Calculator. This can help you see how much your final salary pension scheme could be worth if you transfer out.

What Are The Tax Charges For Exceeding The Pension Lifetime Allowance?

As mentioned, your LTA is the total amount you’re allowed to draw out of your pension savings in your lifetime before tax. If the total value of your combined pension pots is worth more than the LTA, you’ll have to pay Lifetime Allowance Charges.

You could have to pay extra tax if you’re found to exceed the current lifetime allowance. The lifetime allowance tax is typically paid when you withdraw your pension benefits.

If your pension savings go above your personal lifetime allowance, your pension provider will contact you in writing. You’ll then be able to discuss your options and may seek independent financial advice.

Tax Implications

If your pension exceeds the standard lifetime allowance, any excess funds above this figure will be subject to the Lifetime Allowance Charge. The amount of the tax charge you’ll pay will depend on what you use the benefit for.

A tax charge of 25% will apply to funds withdrawn as an income, such as from an annuity or drawdown arrangement. And a 55% tax charge will apply to funds that are withdrawn as a cash lump sum.

To put this into perspective, let’s imagine a high-rate taxpayer who has exceeded their LTA. If they took a pension income of £10,000 per year, their pension income would be cut to £7,500 by the 25% lifetime allowance charge.

This person would then have to pay income tax at 40% on the £7,500, reducing it further to £4,500. This works out to be the same as the 55% charge that would be levied on a lump sum cash withdrawal.

Reaching Age 75

If you have not withdrawn all of your pension benefits by age 75, a lifetime allowance test will occur. HMRC will test your remaining benefits to check if you exceed the lifetime allowance. After age 75, however, there tend to be no further tests against the LTA.

Avoiding The Pension Lifetime Allowance With Tax-Efficient Alternatives

If you are close to the LTA or think you might exceed it soon, you should seek professional financial advice. You can receive the help you need to minimise any tax charges going forward.

In the meantime, you will probably need to stop making contributions. However, this can be a difficult decision, especially if you receive employer contributions too.

For example, let’s say your retirement savings are currently around £720,000 and you are planning to stop work in 10 years. Even if you make no further contributions before then, your fund could easily grow to more than the LTA over this period. This is based on investment returns of 4% a year.

It’s important not to assume you won’t be affected by charges if your pension pot is currently below the allowance.

A pensions adviser will be able to weigh up the various options and help you decide on the best course of action.

Neil Adams
Pension & Investment Adviser

If you are close to, or have already exceeded, the lifetime allowance, then you’re likely to want to cease contributions into your pensions. Instead, you might look into alternative tax-efficient options such as ISAs and investment schemes.

ISAs

Individual Savings Accounts (ISAs) are one of the best ways to save other than pensions. Any returns are free from both income tax and capital gains tax (CGT). Since the 2017/18 financial year, you can invest up to £20,000 per year into ISAs. This could be into a stocks and shares ISA, a cash ISA, or a combination of the two.

There are thousands of different ISA funds to choose from. It’s important to seek advice if you need help building a balanced portfolio which meets your investment objectives.

If you are particularly risk averse, or only investing over a short-time frame, a cash ISA is likely to be more suitable. However, if you do put savings into a cash ISA, the purchasing power of your money may be eroded by inflation over time.

Venture Capital Trusts And Enterprise Investment Schemes

If you have a strong appetite for risk, then other options you may want to explore. For instance, Venture Capital Trusts (VCTs) and Enterprise Investment Schemes (EISs).

VCTs are a type of investment fund similar to an investment trust that invests in very small companies. Meanwhile, EISs help smaller companies to raise finance. They do this by providing tax relief to those who buy shares in these companies.

There are significant tax benefits offered to both EIS and VCT investors. But it’s vital that you understand the risks involved before investing. As these are investments in start-up companies, not all of which will survive, your money is at risk. Also, these investments can be illiquid and difficult to sell, so may not be suitable for everyone.

Can I Protect My Lifetime Allowance?

Depending on your individual circumstances, it may be possible to protect your pension benefits that exceed the LTA.

In the 2016/17 financial year, the LTA dropped to £1million. At the start of the year, there were three protections you could apply to through HMRC. These protections were only available if your pension benefits exceeded the £1million LTA as of 5 April 2016.

You can still apply for the 2016 protection schemes if you meet the eligibility criteria.

Individual Lifetime Allowance Protection 2016

• Individual protection 2016 protects your LTA to the lower of either the value of your pension(s) at 5 April 2016 or £1.25m
• You can’t apply if you already have individual protection in 2014. This protected your lifetime allowance at £1.5m, rather than the £1.25m it fell to that year
• The same is true if you have primary protection. This was the equivalent offered by HMRC in April 2006 to those with pensions exceeding the new LTA of £1.5m
• You can continue contributing to your pension(s). However, you must pay tax on all money taken from your pension(s) that exceed your protected lifetime allowance.

Fixed Lifetime Allowance Protection 2016

• Fixes your lifetime allowance at £1.25m
• You cannot continue building your pension except in limited circumstances or you’ll lose the protection. In this instance, you will pay tax on any pension(s) above the standard lifetime allowance
• You can only apply if you or your employer haven’t added to your pension(s) since 5 April 2016 and you opted out of any workplace schemes by 5 April 2016
• You can apply if you already have individual protection 2014. The fixed protection 2016 will be dormant until you lose previous protection
• You can’t apply if you have primary or fixed protection from previous years, such as 2014.

Individual Protection 2014

• To be eligible, you must have already applied before 5th April 2017
• Individual protection 2014 protects your lifetime allowance to the lower of either the value of your pension(s) at 5 April 2014 or £1.5m
• You can continue contributing to your pension(s). However, you must pay tax on all money taken from your pension(s) that exceed your protected lifetime allowance
• You can still apply if you already have fixed protection 2014 or fixed protection 2016. If you have fixed protection 2016, it will become dormant and individual protection 2014 will apply
• For all other protections, individual protection 2014 will stay dormant until you lose or give up your previous protection
• You can’t apply if you have primary protection

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