How can you lock into a higher pension Lifetime Allowance?
The Lifetime Allowance (LTA) is the maximum amount that you can build up tax efficiently within all of your pension schemes and plans combined. For more information on 'Lifetime Allowance', read our article here.
There is no limit to how much an individual can build up within their pensions, however, the Lifetime Allowance is the overall limit before a Lifetime Allowance tax charge is applied, and this charge can be pretty hefty.
The limit applies to the value of all pension plans held by an individual, including final salary and any personal pensions.
What is the Lifetime Allowance amount?
At present, the Lifetime Allowance in 2021/22 is £1,073,100 and it has been frozen at this amount until the 2025/26 tax year.
It had been set to increase in line with inflation, however, the Spring Budget in March 2021 saw the Chancellor freeze the limit as a way to pay back the mountain of debt incurred as a result of the pandemic.
Whilst the majority of people will stay comfortably within this limit and don’t need to be concerned, some may find that they are close to reaching this limit or in fact have already breached it.
With the freezing of this allowance lasting for five years, even more people may find themselves breaching the Lifetime Allowance, especially if they expect to see high investment growth within their personal pensions. This growth expectation may have been acceptable when the Lifetime Allowance was set to rise but may need to be revised now, otherwise they may find themselves above the line.
When could I be hit with a Lifetime Allowance tax charge?
If you’re concerned that you may breach the Lifetime Allowance or you are already in a position where you are close to it, you do not have to do anything as you will not be charged until specific events take place. These events include:
- Reaching age 75 with uncrystallised funds or funds in drawdown
- Taking benefits from your pension, such as a tax free lump sum, a regular pension amount or placing funds into drawdown
- Passing away before age 75 with funds that you haven’t yet accessed at all (known as uncrystallised funds)
When any of these events takes place, the funds being crystallised will be tested against the Lifetime Allowance and a Lifetime Allowance tax charge could then be applied to the amount that exceeds the current Lifetime Allowance (I.e. £1,073,100 in the 2021/22 to 2025/26 tax years). For example:
- Your total pension pot = £1,400,000
- Your Lifetime Allowance (the amount before tax would be charged) = £1,073,100
- Amount on which a tax charge will be applied (as it exceeds the Lifetime allowance) = £326,900
Charges of up to 55% could apply
If the funds in excess of the Lifetime Allowance are used for an income purpose such as purchasing an annuity or placing the funds in drawdown (even if no income is taken), the excess funds are subject to a 25% lifetime allowance charge (in addition to the normal income tax payable on any income payments). If the excess funds are withdrawn as a lump sum (without going into drawdown first), the 55% lifetime allowance charge will apply (with no further income tax payable).
You could be eligible for protection
Some individuals may be eligible for ‘protection’ which essentially gives them a higher level of Lifetime Allowance, if they have been a member of a registered pension scheme since 2016. The two types of protection schemes that are still available are known as Fixed Protection 2016 and Individual Protection 2016.
You can still register for Fixed Protection 2016 if you haven’t made any pension contributions or built-up benefits in a final salary scheme (defined benefit scheme) since April 2016. If eligible, you can lock in a higher personal Lifetime Allowance of £1.25 million.
All is not lost if you have made pension contributions since 2016, as you may still be eligible for Individual Protection 2016 which protects existing pension funds valued at more than £1million on 5 April 2016. If eligible, your protection figure would be equal to the total value of your pension benefits on 5 April 2016 but capped at £1.25 million. Of course this would currently only give any benefit if your total benefits at 5 April 2016 were valued at more than the current lifetime allowance of £1,073,100.
If you believe you are affected by the Lifetime Allowance or would like advice on protecting your allowance, why not arrange a free consultation with one of our advisers at The Private Office?