Retirement seems a long way off when you start saving, but the years soon catch up and so do the limits on how much you can put in your pension pot.
The tax man thinks about all your pensions as one amount of money and if your pot is more than the lifetime allowance you can trigger a penalty that severely impacts the value of your savings.
The good news is you can take some action to protect your retirement savings and expats have some tax hacks that lets them break the lifetime allowance rules without penalty.
Read on to understand the rules and the action you can take to shatter the glass ceiling that limits your retirement saving.
Lifetime Allowance Limits
The lifetime allowance changes on April 6 each year in line with inflation set by the Consumer Price Index (CPI).
For 2020-21, the lifetime allowance, or LTA for short, is £1,073,100.
The limit applies to all your UK pensions – but excludes expat pensions such as QNUPS (Qualifying non-UK Pension Scheme), QROPS (Qualifying Recognised Offshore Pension Scheme), international SIPPs and the State Pension.
Your LTA limits may differ from £1.073 million if you have individual or fixed protection from 2016 when LTA rules changed.
Calculating Your Lifetime Allowance
The lifetime allowance is compared with the value of your pensions every time you are paid some money from one of the funds.
You can keep an eye on if your pension savings are coming close to the lifetime allowance by regularly monitoring the value of your savings.
The value is calculated differently for each type of pension, so you must figure out how much each group of funds is worth and then add them together:
Defined contribution pensions
Typically, these are more modern workplace pensions and most personal pensions.
Defined contribution, or DC pensions, pay outs are based on the value of the underlying funds which will rise and fall in line with the price of any pension fund investments. Because of this, the benefits are not guaranteed.
The pot is always the value of the fund which would or does pay any regular retirement income or one-off lump sums.
Defined benefit pensions
You can work out how much each defined benefit fund is worth by taking the forecast of your annual pension the fund is expected to pay and multiplying by 20.
This does not include any lump sums, which must be added separately.
Lifetime Allowance red lights
- Watch if your total defined benefit, or DB pension value, with no separate lump sum is approaching £53,655 a year
- Some tax-free lump sums paid to your loved ones if you die before the age of 75 are included in the lifetime allowance
- Once you reach 75 years old, the tax man will check if your pension savings break the lifetime allowance limit at the time
- The tax man will check your lifetime allowance is not breached when you start taking money from a pension
Penalties If You Breach The Lifetime Allowance
If your pension savings are more than the lifetime allowance, a penalty on the excess called the lifetime allowance charge falls due on top of any tax you pay on money from your pension anyway.
Don’t forget, the lifetime allowance limit that pension values are measured against is the one in force for the tax year when the test is carried out.
The cost of the penalty depends on how you received the money from your pension.
Lump sum payments
Your pension provider will carry out the lifetime allowance test and deduct tax at a rate of 55% of any amount that exceeds the LTA.
Pension income covers regular payments taken from a pension, including buying an annuity.
The lifetime allowance charge is 25% of the excess amount.
But beware, you cannot avoid the 55% lifetime allowance charge by taking money from a pension as regular income if you are a higher rate taxpayer.
For example, if you plan to take £12,000 a year from a defined contribution pension as monthly income of £1,000, you will pay the 25% LTA charge as well as 40% income tax on the remaining income.
So, the charge reduces monthly pension income to £750, and then the 40% income tax charge takes around another £300, leaving £450 – a total tax charge of 55%.
If your defined benefit pension breaks the LTA, your provider will deduct tax at source and pay a reduced income.
Protecting The Lifetime Allowance
The government decided to change lifetime allowance rules in 2016, but this would have left many wealthy pension savers facing financial penalties for following official guidance, so anyone who had more than £1 million in pension savings on April 5, 2016, was granted protection that excluded them from penalties.
Pension savers who have breached the £1 million limit on that date can still apply for individual or fixed protection.
Check to see if you qualify for protection
HM Revenue & Customs has an online tool for checking qualification for LTA protection.
Individual Protection 2016
Individual protection was granted to pension savers who qualified for earlier enhanced or fixed protection between 2012 and 2016.
Individual LTA Protection gives retirement savers a new LTA to the lower of the value of their pensions on April 5, 2016 or £1.25 million.
The protection does not mean pension saving has to stop but breaching the new LTA level still attracts the LTA charge.
Fixed Protection 2016
Fixed protection sets the lifetime allowance at £1.25 million, but savers must:
- Stop saving into an auto-enrolment workplace pension
- Stop saving into any defined contribution pensions
- Consider leaving any defined benefit pension
Continuing to contribute could take your total pot over £1.25 million and trigger tax penalties.
QROPS And The Lifetime Allowance
QROPS are specialist offshore expat pensions that come with a built-in solution for retirement savers heading towards the lifetime allowance charge.
Two rules apply to transferring one or more UK pensions to an offshore scheme:
- Pension providers will test the value of funds transferred into a QROPS against the lifetime allowance.
If the fund exceeds the individual’s LTA, a tax penalty is applied
- Once a UK pension is transferred to a QROPS, LTS rules no longer apply and the fund can grow without any fear of triggering the LTA charge
This tax hack allows retirement savers with pension funds likely to breach the LTA a haven for their retirement savings – providing a transfer is made before the fund breaches the LTA.
Read more about QROPS Lifetime Allowance
Taking your pension as a lump sum to avoid the LTA charge
Another way to avoid the LTA charge if you are aged 55 years or older is to take the pension as a lump sum under flexible access and then reinvest the funds – but this could trigger tax on the withdrawal.
However, even at the 45% additional rate, tax paid will still be less than the LTA charge.
Lifetime Allowance For Pension Savers FAQ
The lifetime allowance and the different protection levels are complicated financial arrangements best discussed with a professional adviser.
It’s easy to fall into an expensive tax trap if you don’t consider all the possibilities.
The lifetime allowance is the total amount an individual can save into a UK pension during their lifetime, including employer contributions.
For 2020-21, the lifetime allowance is £1,730,100 with the amount increasing in line with inflation at the start of each tax year (April 6).
The best way to monitor your aggregate pension savings is to carry out a pension review to benchmark the current fund value and to keep an eye on fund growth v LTA hikes at regular intervals, but no less than at two-year intervals.
Ask your pension providers to help or you can hand the job to a suitably qualified IFA.
Your pension provider will issue a statement showing the value of your fund and any LTA charge due. Any tax due is deducted by the provider.
Pension savers must report the tax due on their self-assessment returns on the SA101 section.
Yes. Speak to HMRC as they will send a tax bill to the person or persons who inherit the fund
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