Lifetime allowance: is paying a tax charge such a bad thing?

The lifetime allowance in a nutshell

There’s no limit on the value of pension savings that can be built up by an individual. But, if the value of pension savings taken exceeds the lifetime allowance at a benefit crystallisation event, the excess (known as the ‘chargeable amount’) is subject to a tax charge. This known as the lifetime allowance charge.

The lifetime allowance is currently £1,073,100 but it’s not always been this amount. Historical lifetime allowance figures can be found on our rates and factors page.  

How much is the charge?

It depends on how the individual takes their benefits. Any excess over the lifetime allowance can be taken as a lump sum (a lifetime allowance excess lump sum) and the charge is 55%.

Alternatively, the excess can be used to provide an income, by either a pension annuity or income drawdown. The charge is then 25% but of course any pension instalments or withdrawals made will be taxed at the individual’s marginal rate of income tax.

Protection from the lifetime allowance charge.

Benefits may have protection from the lifetime allowance charge; effectively locking the lifetime allowance at a certain rate. Our primary and enhanced protection, fixed protection, and individual protection articles gives more information on how these work.

Of course, an individual may choose to stop paying into their pension in the hope of avoiding the lifetime allowance charge: “Why would I want to give the tax man more of my money?”. But is this best course of action?

Let’s see.

Macauley lives in England, he's a 40% taxpayer aged 55 with pensionable earnings of £80,000. Over and above his salary, he receives performance related bonuses each year, the first 50% of which is also pensionable. These bonuses have been £20,000 a year over the last 5 years. Macauley plans to retire at age 60 and is thinking of opting out of his employer’s scheme. His employer currently pays 8% contributions as standard and employee contributions are matched 1 for 1 to a maximum of a further 6% of contributions. His current pension pot is £920,000. 

Assumptions:

¹Lifetime allowance is frozen at £1,073,100 until 6 April 2026. However, the calculation assumes that it remains at this level for 5 years from the present day.

²Macauley’s pensionable salary increases by 2.5% each year with bonuses remaining unchanged.

³Investment growth of 4% each year.

In each of these options, Macauley will face a tax charge on retirement at age 60. But, in option 2, where he chooses to stay opted in (but not pay any personal contributions) this will provide an additional net fund of £19,070 (£1,112,949 - £1,093,879) compared to option 1.

Whilst option 3 comes at a cost to Macauley, it produces a higher pension fund net of the lifetime allowance charge. Compared to option 2, Macauley will accrue additional net funds of £28,574 (£1,141,523 - £1,112,949) for a net cost to him after tax relief of £16,938.

This shows that the potential benefits from staying in the scheme and continuing to pay personal contributions, outweigh Macauley’s costs including the lifetime allowance charge.

Comparing option 3 with option 1, Macauley will accrue additional net funds of £47,644 (£1,141,523 -£1,093,879) which shows the potential benefits of continuing to pay personal contributions instead of opting out of the scheme.