How to Pay Less Tax – Lifetime Allowance

Lifetime Allowance

The rules surrounding Lifetime Allowance should be on your radar if the value of your pensions is close to £1,073,100 or if it has the potential to reach this figure by the time you retire.

What is a Pension Lifetime Allowance?

A limit exists when it comes to the amount of tax privileged pension funds that you can accumulate during your life. This is known as the Lifetime Allowance.

In simple terms, the Lifetime Allowance is the limit on how much you can take advantage of pension benefits while still enjoying full tax benefits. You’ll have to pay a tax charge if you go over the allowance. This will be charged on the excess whether you choose to take your pension as a lump sum or as income.

What is the Lifetime Allowance?

The Lifetime Allowance at the moment is £1,073,100. That means you can accrue up to £1,073,100 in pension funds before you’re charged a tax charge on the excess.

What is the Tax Charge of a Lifetime Allowance?

The tax charge applied to any excess depends on how it is paid. It will be 25% of any income and 55% of any lump sum. This charge will fall on both the scheme administrator and the pension-holder, if they are still alive. Before any retirement payment is received by the pension-holder, the scheme administrator will deduct the tax charge.

What Counts Towards Lifetime Allowance?

When figuring out whether you’re nearing the Lifetime Allowance limit or not, make sure you include all final salary schemes (also known as defined benefit schemes), personal pensions (also known as defined contributions), and any pension that you’ve received either a lump sum or an income from.

The only exception is your state pension, which doesn’t count towards your Lifetime Allowance.

When Does Lifetime Allowance Apply?

Your pension will be tested against the Lifetime Allowance limit whenever a benefit crystallisation event occurs. Examples of these events include:

  • When you take benefits
  • When you die
  • When you transfer to a QROPS: a Qualifying Recognised Overseas Pension Scheme
  • When you reach the age of 75

This means you won’t be charged at the moment you exceed the limit, but at the moment you crystallise your pension savings. A charge will then be applied on any amount that exceeds £1,073,100.

How Can I Reduce Lifetime Allowance Charge?

You might think it makes sense to stop contributing to your pension to avoid the Lifetime Allowance charge, but this would actually be counterproductive. You could be left worse off by abandoning your pension contributions than you would be if you were charged the Lifetime Allowance charge.

There are other steps you can take to avoid or minimise this charge, however.

Take the maximum tax-free cash entitlement

Many final salary schemes can pay a tax-free lump sum on top of an annual income. There may be the option to exchange part of your pension entitlement for some tax-free cash, although a limit will undoubtedly apply.

This calculation is determined by dividing the tax-free cash by a commutation factor, which is decided by your pension scheme. With this information, you can figure out how much your pension needs to be reduced to access this additional tax-free cash pay out. Then, the overall value of the benefits that will be included in the Lifetime Allowance test will be reduced.

Consider retiring early

Your pension provider may be able to offer a reduced income level so that you can begin taking benefits early. That might reduce the value of your pension to avoid the threshold of the Lifetime Allowance.

Wait to take your pension

Instead of retiring and accessing your pension early, you could also wait to take your pension. How would this help? Because the lifetime allowance generally does not apply after the age of 75. The pension won’t be tested again in your lifetime. This is a useful option if you’re planning to pass on your pension after your death.

Mitigate the Lifetime Allowance tax charge

You might apply for Fixed Protection 2016. This increases your lifetime allowance to £1.25 million. You might also choose to apply for Individual Protection 2016. Eligibility depends on whether your pensions had a value of at least £1 million on 5 April 2016. You’ll then receive a personalised lifetime allowance that matches the value of your pension savings as at that date, up to a maximum of £1.25 million.


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