As a nation, we are beginning to save more money for retirement. What with the government’s auto enrolment scheme, we are starting to put money into our pensions earlier than ever. But does this mean we are all running the risk of hitting our lifetime allowances? If so, what happens then?
What is the current Lifetime Allowance? (LTA)
The lifetime allowance (LTA) is a cap the government put on the amount we can save into our pension pots, tax-free. It applies to the total of all the pensions you have.
The 2019/20 tax year brings an increase of the LTA from £1,030,000 to £1,055,000. The allowance is indexed every year in line with the Consumer Price Index. Therefore, it is expected to increase with inflation.
The current cap is a nice chunk of money which may seem more than you will ever save. You don’t have to be a high earner to reach the threshold, however. Consider this; if you are paying in to your pension pot over a 40-year career with a moderate income, and have some successful investment, the LTA is easily within your reach.
What happens if you hit your lifetime allowance?
You will be charged the lifetime allowance charge (LTAC) on any excess money in your pot. The amount you are charged differs, depending on if you are receiving the money as a lump sum or income.
Additional money taken as a lump sum is taxed at 55%. The tax will be taken by your pension scheme administrator and paid directly to HMRC.
over the LTA which you take as regular retirement income is taxed at 25%.
The LTAC charged is in addition to any other tax that is payable on your income.
Your pension scheme administrator should pay the 25% of tax to HRMC from your pension pot, leaving the remaining 75% to be used as your retirement income. They may also choose to pay the tax on your behalf and recover it from you by reducing your pension.
Don’t forget, when you receive your pension as an income, you are charged Income Tax on the payments. The tax payable works out to be roughly the same whether you take your money as a lump sum or income.
Say a person who pays tax at the higher rate expects to get £1,000 a month as income, but the lifetime allowance charge has reduced this to £750 a month. Income tax would be charged on the £750 at a rate of 40%. Leaving the individual with £450 a month. Therefore, the monthly income payments have been reduced by 55%. The same amount as if the money had been taken as a lump sum.
What can you do if your reach or exceed your LTA?
Remember; it’s the sum of money in your pot at the time of retirement which determines if you have reached your LTA. Therefore, the best way to avoid paying the LTAC is to closely monitor the value of your pensions. Be sure to also keep an eye on any value changes to defined benefit pensions.
If you are concerned that you are approaching, or likely to reach your LTA limit, get a pension valuation from your provider.
For those who have reached, or exceeded, their LTAs, there are a few options to consider. You could retire early or simply stop paying into your pot. You may qualify for more gratifying solutions, however.
Claiming a higher lifetime allowance
The lifetime allowance hasn’t always been set at the same limit. Since it was introduced the LTA has changed a number of times. In 2016 alone the LTA reduced from £1.25 million to £1 million. This meant there were a number of people who already had more than the new allowance in their pension pot.
You could be entitled to a higher LTA if you qualify for one of these two reasons:
Fixed Protection 2016 – If you, or your employer, haven’t made any pension contributions since 5th April 2016, you can apply for Fixed Protection 2016. This will give you a lifetime allowance of £1,250,000.
Individual protection 2016 – If your funds were over £1,000,000 at 5 April 2016, you could reapply for individual protection 2016. This gives you a lifetime allowance of the value of your pension rights at 5th April 2016, subject to a maximum of £1,250,000.
The rules surrounding these allowances can be complicated and it is possible to lose your protection. If you think you are able to claim a higher LTA, be sure to seek advice from an expert before applying. This could be your pension administrator or a regulated financial adviser.
Pay into your Spouse’s Pension Pot
If your pot is full, you could top up your partner’s pension pot instead. But remember, contributions will also be limited by their annual allowance.
Pay into an ISA
Even if you have hit your LTA, you can still save money for your retirement by saving into an ISA for example. Contributions into an ISA don’t benefit from tax relief, but the money you withdraw will be tax-free.
You can save up to £20,000 in your ISA each tax year, which is a nice tidy sum to help you enjoy a comfortable retirement!
The most important thing to remember is always seek independent advice. This will ensure you make the most of the money you have saved and avoid costly mistakes.