17 February 2022
The value of the pension lifetime allowance (LTA) has changed considerably over the past decade. Most recently, Chancellor Rishi Sunak froze the LTA at its current level of £1,073,100 until April 2026, meaning more people than ever face paying the tax.
The LTA is the maximum amount you can build up in pension benefits over your lifetime without incurring a tax charge. Any pension benefits valued above the LTA will be subject to the lifetime allowance charge of 55% if taken as a lump sum or 25% if taken as income.
While a £1m pension pot may seem substantial, as pensions benefit from investment growth and compound interest, Quilter is warning that even a pension worth around half the current level of the LTA has the possibility of falling foul of the tax charge over time.
Assuming the LTA remains frozen until the 2026/27 tax year and then increases by CPI thereafter, someone with a £500,000 or £600,000 pension pot and who is around 15 to 20 years from retirement may well be forced to hand over some of their hard-earned cash to the taxman:
|
Pension value now to hit the LTA in 5 years |
£857,648 |
|
Pension value now to hit the LTA in 10 years |
£741,914 |
|
Pension value now to hit the LTA in 15 years |
£641,869 |
|
Pension value now to hit the LTA in 20 years |
£555,271 |
|
Pension value now to hit the LTA in 30 years |
£415,577 |
*Assumes 5% growth per annum net of charges, without any personal or employer contributions
While it is expected that from 2026/27 the LTA will once again be allowed to increase in line with CPI inflation, this is by no means certain and should the LTA remain frozen for a longer period of time then savers with a large pot will hit the LTA quicker. And if you or your employer are making contributions to their pension as well, then you’ll hit the LTA even sooner.
Jon Greer, head of retirement policy at Quilter says:
“While having a pension pot worth £1m may sound unattainable, thanks to investment returns and compound interest, the LTA can be easier to hit than many people think.
“Our calculations show that even someone with a £500,000 or £600,000 pension pot, around 15 to 20 years from retirement may well be forced to hand over some of their hard-earned cash to the taxman.
“This is assuming 5% net investment growth and doesn’t take into account any personal or employer contributions which will substantially speed up growth.
“If you believe you are at risk of hitting the LTA, then you’ll need to have a solid plan of action. If possible, you should seek finance advice to ensure you are making the best possible decisions for your personal circumstances.”
Jon’s tips for reducing the risk of hitting the LTA:
- Use ISAs: Instead of contributing to your defined contribution pension, you could instead contribute to an ISA, if you have any allowance (up to £20,000 a year) remaining. However, if you are part of a workplace pension scheme, it is more than likely that you should continue to accrue benefits within the scheme to benefit from the employer contribution, even accounting for the lifetime allowance charge. However, it is important to know how much you may be required to pay to benefit from the employer contribution (some workplace schemes don’t require an employee contribution to still benefit from the employer contribution).
- Use a spouse’s pension: If you are at risk at hitting the LTA, it might be worth redirecting your contributions into your spouse’s pension instead of your own. Of course, this is not risk free given it introduces the danger of divorce, but it does essentially double your lifetime allowance given you can use your spouses’ allowance as well.
- Check if you have any protections: When the government reduced the LTA previously, they did at least offer some protections to allow certain people to keep the older, higher LTA. You can apply for Fixed Protection 2016 if you have not made any pension savings since 5 April 2016, and you’ll get an LTA of £1.25m. You may also be able to apply for Individual Protection 2016 if your pension savings were worth more than £1m at 5 April 2016, and you’ll get an LTA of the lower of £1.25m or the value of your pension rights at 5 April 2016.
- Consider the timing of taking your pension benefits: When you take pension benefits your pension funds are tested against the lifetime allowance. It may be worth seeking the help of a financial adviser to understand whether there is a strategy to help reduce the impact of the lifetime allowance tax charge whilst still meeting your retirement income needs.
