The Pension Lifetime Allowance and Avoiding the Lifetime Allowance Charge

The pension lifetime allowance is the maximum you are allowed to build up in pension benefits before a lifetime allowance charge is applied. Keeping track of your pensions and using pension lifetime allowance protection can help you avoid the lifetime allowance charge.

Tim Leonard Published on 15 September 2021.
The Pension Lifetime Allowance and Avoiding the Lifetime Allowance Charge

Saving as much as you can into a pension is essential if you want to be financially prepared for retirement, but perhaps surprisingly it may be possible to save too much. This is because if your pension fund is large enough to exceed the pension lifetime allowance, you will face a tax charge.

How does the pension lifetime allowance work?

The pension lifetime allowance – which is sometimes shortened to pension LTA – is the maximum amount you are allowed to accumulate in pension benefits during your lifetime before a tax charge will be applied. The lifetime allowance charge will only apply to the excess benefits you have above the lifetime allowance, but can be significant nonetheless.

The lifetime allowance should not be confused with the pension annual allowance, which limits how much you can contribute to a pension each year before tax charges apply.

» MORE: All about pension contributions

What is the current pension lifetime allowance?

The pension lifetime allowance for the 2021/22 tax year is set at £1,073,100, and is due to remain at this level through to at least 2025/26.

In the past, the lifetime allowance has been as high as £1.8 million (in the 2010/11 and 2011/12 tax years), but by 2016/17 it had been reduced to £1 million. The decision to link the allowance to inflation from 2018/19 saw the lifetime allowance begin to rise again, but in the Spring Budget 2021, the Chancellor froze the allowance at its current level for five years.

How is the pension lifetime allowance calculated?

The lifetime allowance takes into consideration the combined value of all of your pensions. This includes:

However, the lifetime allowance does not include the benefits you could receive under the state pension.

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When is the pension lifetime allowance calculated?

A review of the value of your total pension benefits to check whether they exceed the pension lifetime allowance is normally only made when certain events occur:

Whenever you access your pension

Generally, a check is required if you begin taking benefits from a DB scheme; you take a lump sum; or begin drawing an income from a DC scheme.

The lifetime allowance charge at age 75

Which side you are of age 75 can also be important regarding other events that can trigger a review of your lifetime allowance. A check will usually be conducted if:

  • You are younger than age 75 and transfer a pension overseas.
  • You die before reaching 75 with a pension you have not taken benefits from.
  • You reach age 75 with a pension that you are yet to take benefits from or is being accessed through income drawdown.

After age 75, there won’t usually be any more reviews relating to the lifetime allowance.

How do I calculate my pension lifetime allowance?

If any of these events occur, your pension provider will want to check whether you are within the lifetime allowance. Expect them to ask about all of the pension benefits that you have, so they can get the full picture.

How your pension benefits are calculated to test them against the lifetime allowance differs between pension types:

  • For defined contribution schemes, the current value of your pensions will be added together.
  • For defined benefit schemes, the total value is usually calculated by multiplying your expected annual pension by 20. Any tax-free cash lump sum you receive must be added too.

The reason for the check on your lifetime allowance will also influence what is assessed:

  • If a review is triggered because you are taking benefits from your pension, it will be made against the overall value of the amount you are accessing, rather than only the lump sum or income you’re taking.
  • When a check is needed because you have reached age 75, the value of any pensions you are yet to access or are already using for drawdown will be included.

Contact your pension provider(s) to get your latest pension valuations and for help with calculating the lifetime allowance you have used. Some providers may also have a pension lifetime allowance calculator on their website to help further.

Lifetime allowance calculation examples

The following lifetime allowance examples illustrate how much will be counted against your allowance in some common scenarios.

Defined contribution examples

If you have a pension pot worth £100,000, and:

  • You take your 25% tax-free cash lump sum (£25,000) and use the rest to take an income by entering drawdown or buying an annuity, the amount that is counted against your lifetime allowance is the entire £100,000.
  • You withdraw £25,000 as an Uncrystallised Funds Pension Lump Sum (UFPLS) – so you don’t cash in the rest of the fund via drawdown or an annuity – only the £25,000 would count towards your allowance at this time. The £75,000 left in your pension would then usually be tested as you make more withdrawals or at age 75.

Defined benefit example

For a final salary pension paying £20,000 a year and a tax-free cash lump sum of £40,000, the value that would count towards your pension lifetime allowance would be £440,000 (£20,000 multiplied by 20, plus £40,000).

You should be aware that even a small uplift in defined benefit scheme benefits can cause a relatively sharp uptick in the use of an allowance.

What happens if you go over the pension lifetime allowance?

Your pension provider will notify you if a review establishes that you have pension benefits in excess of the pension lifetime allowance. You will then have to pay tax, known as the lifetime allowance charge, on any amount above the allowance.

The tax that you owe will be deducted by your provider before you begin receiving your pension, but you must report it to HMRC via a self assessment tax return.

What is the lifetime allowance charge?

What you pay under the lifetime allowance charge depends on how you take the excess benefits. If you opt for:

  • a lump sum, it will be taxed at 55%
  • an income, the tax charge is 25%

What is pension lifetime allowance protection?

Keeping track of your pensions can help you stay under the lifetime allowance and avoid a lifetime allowance charge.

However, given you may have previously saved into a pension to maximise benefits in line with a higher lifetime allowance from a previous year, you may have the option to protect your pension lifetime allowance. Two types of protection are available, both of which reflect the decrease in the allowance from £1.25m to £1m in April 2016:

Individual protection 2016

Individual protection 2016 protects your allowance at the lower of £1.25m or the value of your pension as it stood at 5 April 2016.

Opt for individual protection 2016, and you are allowed to continue contributing to a pension, but will be taxed on the pension savings you accumulate above your protected allowance.

Fixed protection 2016

With fixed protection 2016, your pension lifetime allowance is protected at £1.25m, but you can’t make further contributions. If you do, you’ll lose the protection and must pay tax on the excess when taking benefits.

As a result, fixed protection 2016 usually suits you better if you don’t want or need to add to your pension.

Are you eligible to protect your pension lifetime allowance?

You must meet certain criteria if you want to apply for the lifetime allowance protections. If you hold certain protections that have been available before, such as primary or enhanced protection, you may not be able to apply now.

Primary protection was introduced when the lifetime allowance was launched on 6 April 2006 to provide those with pension savings above the original allowance of £1.5m at that date with a higher allowance.

Enhanced protection was introduced at the same time and could be applied for by anyone with pension savings at that time rather than just those with pensions above £1.5m. The option to apply for both primary and enhanced protection ended in April 2009.

Individual protection 2016 Fixed protection 2016
To be eligible: your pension must have been worth over £1m at 5 April 2016 no pension contributions must have been made by you or an employer since 5 April 2016
you must have opted out of any workplace pensions by 5 April 2016
You can still apply if you have: enhanced protection individual protection 2014
fixed protection
fixed protection 2014
fixed protection 2016
You cannot apply if you have: primary protection enhanced protection
individual protection 2014 primary protection
fixed protection
fixed protection 2014

Note that any new protection will be dormant until your previous protection is lost.

Applying to protect your pension lifetime allowance

If you want to protect your lifetime allowance, you can apply online to HMRC through the website. A Government Gateway user ID and password is required but these can be created at the same time as you apply for protection. Alternatively, you can call HMRC on 0300 123 1079.

There is no deadline, but protecting your pension lifetime allowance can be a complicated part of retirement planning. If you are in any way unsure, it’s always best to seek advice.

» MORE: Find out about pension advice

Image source: Getty Images

About the author:

Tim draws on 20 years’ experience at Moneyfacts, Virgin Money and Future to pen articles that always put consumers’ interests first. He has particular expertise in mortgages, pensions and savings. Read more

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