When the Lifetime Allowance (LTA) was introduced in 2006, it stood at £1.5 million, peaking at £1.8 million four years later.
In recent years, however, the LTA has dropped significantly.
It is now frozen at just £1,073,100 as part of the government’s response to Covid overspending. The Treasury estimates that the freeze will raise an additional £990 million by 2026.
No longer a concern only for high earners, a recent report published by Money Age suggests that the average UK worker could now be in danger of breaching the allowance.
What does this mean for you and your clients’ retirement plans? And is breaching the LTA always to be avoided?
Read seven key points to consider in your guide to the LTA.
1. Exceeding the LTA leaves pension funds liable for an LTA charge
Introduced on “A-day” back in 2006, the LTA doesn’t limit the size of pension pot that your clients can build up, but it does leave them liable to a potential charge when withdrawals are made.
The charge only applies to those funds in excess of the threshold when funds are tested against the LTA.
For the 2022/23 tax year, the LTA charge is 55% for excess funds taken as a lump sum and 25% where the excess is withdrawn as income.
2. Pension funds are tested against the LTA when certain events occur
The LTA isn’t triggered the moment pension funds exceed the threshold. Instead, your client’s pot will be tested against the LTA whenever a benefit crystallisation event (BCE) occurs.
There are 13 BCEs in all, covering different types of pension withdrawals and life events – for example, several different BCEs could occur at age 75, depending on whether or not benefits have been taken.
We can help your clients to understand when a BCE might occur. This will help manage their retirement fund tax-efficiently in the lead-up to a test against the LTA.
3. The LTA isn’t static – although it is currently frozen
After a £1.8 million high, the LTA dropped to £1 million by 2016/17.
It began to rise in line with the Consumer Price Index (CPI) from the 2018/19 tax year. Coronavirus borrowing, though, caused then-chancellor Rishi Sunak to freeze the allowance for at least five years, from 2021/22.
The almost £1 billion that this freeze is expected to raise will come from two main areas. Firstly, from LTA charges, but also from a reduction in tax relief as retirees stop making pension contributions.
4. It might be possible to protect your funds against the LTA
When the LTA began to drop, the falling threshold could have disadvantaged people saving diligently toward the previous limit. For this reason, HMRC introduced a series of protections.
The deadline for applying for some of these protections passed as subsequent changes occurred, but there are still some that can be applied for.
Individual Protection 2016 makes it possible to adopt a new LTA, based on the value of retirement funds on 5 April 2016. Fixed Protection 2016, meanwhile, increases an individual’s LTA to £1.25 million.
There are consequences to both types of protection that need to be carefully considered. Taking professional financial advice before deciding is crucial.
5. Even an average pension pot could exceed the frozen LTA
Recent research has found that if the LTA freeze remained in place, the average worker aged 18 to 20 could exceed the allowance on retirement at age 65.
If your clients are closer to their retirement date, they could be even more vulnerable. A £750,000 pension pot, growing at 5%, would exceed the £1,073,100 allowance in around seven years.
Individuals with a pension pot around this size should start making plans. It might be time to decrease or stop contributions and redirect the funds.
6. Exceeding the LTA isn’t “wrong” and paying the charge might be the right option for some
The most important thing that your clients can do to protect themselves against the LTA charge is to be aware of it.
Understanding that the LTA exists is vital, along with the events that could trigger a test against it, and the different rates of tax that might apply. This allows individuals to decide if the charge is the most tax-efficient option for them.
7. Speak to the experts
At Boolers, we can help your clients to weigh up their options.
The first step will be to obtain up-to-date pension statements and valuations. We can then calculate the size of the fund, examine their different income streams, and decide how and when they trigger a charge if they need to.
Redirecting money into other tax-efficient savings vehicles, such as an ISA, might help to avoid a charge for clients close to the threshold. For clients in greater danger of exceeding the limit, we can help examine protection options and weigh up the tax efficiency of paying the charge.
Get in touch
If you have a client who would benefit from help managing their pension funds in the approach to retirement, please get in touch. Our expertise and experience could help your client to avoid an unnecessary LTA charge. Email email@example.com or call 0116 240 7070.
The value of investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.
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