More than 1 million people likely to breach the lifetime allowance
Many people don’t consider the Lifetime Allowance (LTA) as something that will impact them. However, over 1 million people will breach the threshold and be landed with a hefty tax bill.
What is the Lifetime Allowance?
The Lifetime Allowance is the upper limit on the total value of payouts that can be taken from all of your pension schemes without a tax penalty.
It was introduced in 2006 at £1.6 million and had risen to £1.8 million by 2010. It was then cut over the following 6 years to £1 million and changed again in 2018 to rise in line with inflation. Currently, it stands at £1,073,100 for the 20/21 tax year. It is fair to assume that the value of pension pots will grow over time faster than inflation, meaning that an increased amount of people will be impacted over the years.
The LTA test is applied by your pension provider when you access a pension, and this calculates what proportion you have used and what you have left. A breach of the Lifetime Allowance could result in a hefty tax charge. Accessing your pension is what is known as a Benefit Crystallisation Event (BCE), of which there are 13 different types. BCE cover just about ever way of withdrawing money from your pension. It is also common for multiple BCE’s to happen at the same time, such as in the instance where you take a lump sum and draw flexibly at the same time. The rules around this change when you are over 75 also.
In this short video Chris explains LTA (Numbers quoted were accurate at time of filming and have since changed to the amounts mentioned above):
Lifetime allowance
What if You Breach the Lifetime Allowance?
How the penalty for breaching the LTA is levied depends on how you have accessed the pension. If you take a cash lump sum, the pension administrator will take 55% of the amount above the LTA and pay it to HMRC before paying over the balance to you. So, if you withdrew £100,000 from your pension as a lump sum and the whole lot exceeded the LTA, you would receive £45,000 after the 55% penalty.
If you withdraw as an income and or buy an annuity, the administrator withholds 25% of the amount exceeding the LTA before allocating the balance. Then, when you draw an income or receive annuity payments, you pay income tax as usual. So, if you withdrew £100,000 as income drawdown, £75,000 would be paid into your drawdown account after the 25% penalty. Higher-rate taxpayers would then lose 40% of that as tax when they took income, ending up with £45,000 in income payments, while basic-rate taxpayers would lose 20%, receiving £60,000.
Can I Avoid Breaching the Lifetime Allowance?
There are a couple of protection options that can be used if you think you may exceed the LTA.
- Fixed Protection 2016 can only be used if there have been no contributions to your pension pot since April 5, 2016, whether or not you’re still working. It enables you to fix your LTA at a higher level of £1.25 million, though the penalty charge will apply as usual to any pension savings you take above that.
- Individual Protection 2016 is available to those who had more than £1 million in pension savings on April 5, 2016, and gives them protection equal to the lower of the amount in their pension at that point or £1.25 million. They can carry on contributing under this scheme, but any additional contributions above that enhanced level will likely attract the penalty charge.
If you do breach the Lifetime Allowance it is not the end of the world. You still get tax relief on your contributions, and still benefit from employer contributions. What really matters is what you’ll get back after the LTA charge has been deducted, and that’s not easy to work out. If you think this may affect you, speak to one of our advisors today.
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