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.
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.
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?
Macauley lives in England, is a 40% taxpayer aged 55 with pensionable earnings of £80,000. Over and above their 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.
|Macauley opts out||Macauley stays in the scheme|
Employer contribution only (8%)
|Macauley stays in the scheme|
Employer + employee contribution (14% + 6%)
|Lifetime allowance in 5 years’ time1||£1,073,100||£1,073,100||£1,073,100|
|Net cost to Macauley||£0||£0||£16,9382|
|Fund at retirement3||£1,119,321||£1,161,653||£1,225,151|
|Lifetime allowance excess||£46,221||£88,553||£152,051|
|Lifetime allowance charge (excess taken as lump sum)||£25,442||£48,704||£83,628|
|Lifetime allowance excess lump sum||£20,779||£39,849||£68,423|
|Pension fund after charge||£1,093,879||£1,112,949||£1,141,523|
1LTA remains at £1,073,100 for the next 5 years
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.
The information provided is based on our current understanding of the relevant legislation and regulations and may be subject to alteration as a result of changes in legislation or practice. Also it may not reflect the options available under a specific product which may not be as wide as legislations and regulations allow.
All references to taxation are based on our understanding of current taxation law and practice and may be affected by future changes in legislation and the individual circumstances of the investor.