Lifetime allowance charges see 11% increase

New figures from HM Revenue & Customs (HMRC) have revealed that the number of people breaching the lifetime allowance (LTA) and therefore being hit with an LTA charge is on the rise.  

According to the latest figures, lifetime allowance charges increased by 11% in the 2020/21 tax year. A total of £382m was paid in tax charges by 8,610 people who had exceeded their LTA limit and were drawing down on their pensions. This figure is up from £344m in the 2019/20 tax year.

What is the ‘lifetime allowance’? 

Essentially, your lifetime allowance is the total amount of capital you can accumulate in all your pension savings without being taxed.  

As of the 2022/23 tax year, this allowance is capped at £1,073,100. This includes any employer contributions or investment returns that your pension has amassed over the course of its life.  

If your total pension size exceeds this limit, then you will be taxed on the excess amount when you start to draw upon your pension. The amount you will be taxed depends on how you access the funds. If you take the excess as income, then you will be taxed 25%, but if you take it as a lump sum, it will be taxed at 55%!

If you still have questions, you can find out more about the myths and misconceptions of the lifetime allowance.

The freeze on allowances 

In last year’s Spring Budget, the then Chancellor Rishi Sunak announced that the lifetime allowance limit would be frozen at its current level and would remain frozen for a further 5 years, until April 2026.  

This was a significant move by the Government as it prevents the lifetime allowance increasing in line with inflation, which is currently at double digits. Worst still, there is speculation that the then Chancellor and now PM is looking to extend the freeze on allowances until 2027/28.  

The Government justified this direction by explaining that these kinds of cuts were necessary in order to start paying back the large amounts of debt the treasury had amassed over the course of the pandemic.  

However, with inflation rates at a 30 year high, many pension savers may be feeling the pinch as the tax-free lifetime allowance limit relatively shrinks year-on-year.

How could this impact me? 

If the lifetime allowance had risen in line with inflation, as it was due to, with modest projections this could place it at £1.2million by 2025-26.   

Given the projection above, if your pension fund is worth £1.2 million by 2025/26, £126,900 worth of the pension fund would sit above the currently frozen LTA limit and be subject to an LTA tax charge. Should you take the money as a lump sum you could have a tax liability of £69,795, an amount you may not have had to pay at all had the threshold risen with inflation.   

Even if you fall below this threshold, the freeze on the lifetime allowance means as inflation continues to creep upwards year-on-year, the need to grow your pension is vital to keep pace with the rising cost of living. Those able to save even modest amounts early in their lifetime could easily breach the lifetime allowance limit with good investment performance, so you may well find yourself handing over a portion of your hard-earned savings to the Government in tax.

Negotiating the growth of your pension with the lifetime allowance in mind can be a complicated task. At The Private Office we can offer advice and guidance about how to best navigate this often-tricky area. If you want to find out more, why not give us a call on 0333 323 9065 or book a free non-committal initial consultation with one of our chartered advisers.

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Note: The information contained within this article is based on our understanding of legislation, whether proposed or in force, and market practice at the time of writing. Levels, bases and reliefs from taxation may be subject to change.