The Lifetime Allowance (LTA) is a limit on the pension funds you can withdraw without attracting an LTA charge.
Currently frozen as part of the government’s plan to claw back coronavirus borrowing, the freeze is expected to raise around £990 million for the Treasury. This money will be raised at least partly from retirees breaching the allowance.
Recent reports suggest that, with the LTA frozen, even workers on an average wage could become liable to a charge.
If you are approaching retirement or looking to withdraw benefits, you’ll need to be aware of the LTA.
So, what is it, how much tax might you pay if you breach it, and is this always a problem?
Keep reading to find out.
Exceeding the LTA could see you taxed up to 55% on the excess amount
The LTA is a lifetime limit on the amount you can withdraw from the pension funds you hold. It stands at £1,073,100 for the 2022/23 tax year and is currently frozen at this level until at least 2026.
When you take benefits in certain ways, your pension will be tested against the LTA. These are known as benefit crystallisation events (BCEs) and there are currently 13 of them, including:
If you are found to have exceeded the limit, the excess is liable to an LTA charge. The amount you pay will depend on how you opt to access the funds.
Take the excess as income, and you will pay tax at 25%. Opt to take the additional funds as a lump sum, however, and tax is chargeable at 55%.
Factor the LTA into your plans even if you don’t think you’ll exceed it
A recent report from MoneyAge suggests that an 18-year-old on an average salary would exceed the current LTA by their retirement age.
Peaking at £1.8 million between 2010 and 2012, the LTA subsequently dropped to just £1 million. Money Marketing confirms that over the last five years, the government’s LTA take has increased by 28% a year on average.
The report goes on to claim that 29,757 will be hit by the charge by 2025, potentially raising £1.5 billion for the Treasury.
Remember that your defined contribution (DC) pension plan is comprised of your contributions, employer contributions, tax relief, and investment growth. A pot of just £580,000, growing at 8% a year, would breach the LTA within nine years, assuming no further contributions and an LTA increasing by 2% a year from April 2026.
Consider the tax impact of paying or avoiding the charge
There are many factors to consider as you approach the LTA. Keeping an eye on your fund values as you approach retirement gives you the best chance of choosing the right option for you.
You might consider:
1. Halting your pension contributions
If you are still a way off the LTA or your retirement is imminent, you might calculate that stopping contributions altogether will keep you below the threshold. With longer to go until retirement, investment returns might be harder to predict.
You’ll need to think about where you will redirect the funds to. Do you have any unused ISA subscriptions for the year, for example? If so, you might take advantage of an ISA’s tax efficiency, with returns free of Capital Gains Tax and Income Tax.
2. Reducing your pension contributions
Paying your future self first is a vital part of your financial plan. At Boolers, we can help you to decide if a pension reduction would be sufficient to keep you under the LTA.
As with a halt to contributions, be sure you have a tax-efficient alternative lined up for your funds.
3. Withdrawing the excess as income (unless you’re an additional-rate taxpayer)
The difference in tax charge for excess funds taken as income (25%) compared to a lump sum (55%), will likely mean income is your more tax-efficient option.
You’ll pay 25% on the excess, and then Income Tax at the highest rate you pay on subsequent payments.
The calculations will depend on how much you exceed the allowance by, but as a basic- or higher-rate taxpayer, you might be better off opting for income.
4. Leaving your pension funds unused
Leaving your pensions untouched can be tax-efficient in some circumstances. Be aware, though, that several BCEs occur at age 75 so your funds could still be tested against the LTA.
On death before 75, unused funds up to the LTA can be passed on tax-free to a chosen beneficiary. If you die after age 75, any unused pension amount (up to the LTA) can be passed to your beneficiary but they will have tax to pay.
5. Apply for Lifetime Allowance protection
You might be able to apply to HMRC for Fixed or Individual Protection 2016.
If you are eligible, this could give you a higher LTA, thereby lowering the charge due. There are conditions attached though, so be sure to speak to us before you apply.
Get in touch
If you are worried about the effect of exceeding the LTA on your retirement plans, get in touch. You’ll have some important decisions to make, and while they won’t always be simple, we are on hand to help so contact us today.
A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits.
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