PensionsOct 12 2020

How to cope with the Lifetime Allowance

  • Explain how the lifetime allowance charge operates
  • Identify the key issues a pension scheme member should consider
  • Describe how the LTA affects individuals
  • Explain how the lifetime allowance charge operates
  • Identify the key issues a pension scheme member should consider
  • Describe how the LTA affects individuals
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How to cope with the Lifetime Allowance
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As time goes on, it is becoming clearer how firmly the lifetime allowance has sunk its teeth into private pensions wealth in the UK. 

The level of the lifetime allowance has been on a roller coaster since being introduced in 2006; first rising to the heady heights of £1.8m before falling to a low of £1m.

It is now on a slow drag upwards, having reached £1,073,100 in 2020/21, and should increase each year in line with CPI.

But as pension wealth increases at a faster rate, more people are having to organise their pension affairs to negotiate a possible lifetime allowance charge.

This doesn’t just affect a niche group. Figures from HMRC (published September 2019) show a sharp increase in both the number of lifetime allowance charges paid and the total value of those charges.

Paying a lifetime allowance is no longer an unusual occurrence or the preserve of the super wealthy.

This article explores further the issues people need to consider when planning around a potential lifetime allowance charge and runs through a case study to demonstrate how some of these could play out in practice.

Pension planning - the basics

The lifetime allowance represents the amount of money that can be taken from pensions before the lifetime allowance charge applies.

The amount of pension benefit is tested against the lifetime allowance at a benefit crystallisation event (BCE). A charge will be applied to any excess over the lifetime allowance.

The charge is 55 per cent if the excess is taken as a lump sum, and 25 per cent if the excess is retained within the pension pot (the theory being that when the money is taken as an income 40 per cent income tax will apply making an effective total tax rate of 55 per cent for higher rate taxpayers).

There are 13 BCEs. It is worth pulling out a few key ones. Pension values are tested against the lifetime allowance when benefits are first taken as drawdown, a lump sum, an annuity, or a scheme pension. Uncrystallised benefits are tested at age 75.

But there is also a second test on drawdown benefits at age 75 which measures the investment growth on the funds while in drawdown against the lifetime allowance.

If the member dies before crystallising benefits and before age 75, then the benefits are tested against the lifetime allowance. If the member has previously designated drawdown and dies before age 75 (and the second drawdown test) there is no further BCE. 

Another pension tax rule affecting people’s planning decisions involves the income tax paid by beneficiaries of death benefits. If the member dies before age 75 then no income tax is paid.

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