Understanding Pension Lifetime Allowance
Understanding the Pension Lifetime Allowance changes
When building up pension benefits throughout your life, it has always been important to be conscious of what the limits are in order to maximise the full tax benefits. Helping our clients understand what the pension Lifetime Allowance (LTA) is, and crucially how to protect against it, has formed a significant part of the retirement planning that we do at The Private Office. However there has been a big shake-up to this tax regime this year outlined by the Chancellor of the Exchequer in his 2023 Spring Budget which will impact the retirement strategy that individuals adopt going forward.
What is the Pension Lifetime Allowance?
In the UK, the Pension Lifetime Allowance was a limit on the amount of pension benefits an individual could accumulate over their lifetime without incurring an LTA tax charge. This limit has varied drastically since its introduction in the tax year of 2006/07:
|Tax year||Standard LTA||Tax year||Standard LTA|
|2020/21 to 2025/26||£1,073,100||2012/13||£1,500,000|
|2019/20||£1,055,000||2010/11 and 2011/12||£1,800,000|
|2016/17 and 2015/16||£1,000,000||2008/09||£1,650,000|
|2014/15 and 2015/16||£1,250,000||2007/08||£1,600,000|
An individual would be ‘tested’ against this allowance at various points in time, such as when they begin taking certain benefits, or when reaching the age of 75 for example.
On a crystallisation event (which happens when you start to access your pension either by drawing an income or cashing it in), if there was an excess above the lifetime allowance, there would be a charge of 25% if an individual chose to keep the excess in their pension and use it to provide them with an income, or a 55% charge if taken immediately as a lump sum. However, the key difference was that income tax would also have to be paid on any income withdrawals, and if the individual was a higher rate taxpayer, for example, then there would be a combination of a 25% charge on the excess fund and a 40% income tax on the pension income paid out which equalled a 65% charge overall.
What is changing with the pension lifetime allowance?
Many were expecting the Chancellor, Jeremy Hunt, to make some changes to pension taxation with an expectation that he might increase the allowance to, say, £1,800,000 again like it was in 2010-12.
However, he decided to go a step further and abolish it entirely from 6 April 2024. It’s important to note that this abolition requires legislation in the form of the Finance (No.2) Bill 2023, but this shouldn’t be an issue for the Chancellor to obtain.
Thus, in the meantime, the Government is simply disapplying the charge and setting the 25% tax charge to nil for the current tax year 2023/24, and so only income tax is applicable.
On the following lump sum payments, a member would previously be subject to a 55% lifetime allowance charge:
- Serious ill-health lump sum
- Lifetime allowance excess lump sum
- Uncrystallised funds lump sum death benefit
- Defined benefits lump sum death benefit
From 6 April 2023, this will be replaced with income tax at the recipient’s marginal rate. This can provide planning opportunities because it creates the flexibility for individuals to manage the timing that they receive the income tax charge (i.e. take it when you become a basic rate taxpayer).
Despite this, the figure of £1,073,100 will still be crucial in financial planning for the current tax year, as the upper limit on the tax-free cash someone can take from their pensions is being capped at 25% of the current LTA (£268,275). The only instances where this doesn’t apply would be when an individual has previously registered for one of the many forms of Lifetime Allowance Protection, which may provide a higher personal limit than the figure above.
It is also worth pointing out that they also announced a change to the pension annual allowance from 6 April 2023. The annual allowance is the maximum amount someone can contribute to a pension each year whilst still benefiting from tax relief. This too has been subject to a lot of tinkering over the years; in 2010 the figure was at £255,000 but has been frozen at £40,000 since 2014/15. This has now been increased to £60,000, in most cases, to further incentivise individuals to make contributions.
Who do the lifetime allowance changes affect?
Whilst this is a politicised topic, there’s no hiding the fact that this change will primarily impact and benefit those who are either closing in on that current LTA figure, or for those high earners who anticipate their pension benefits will likely exceed this in the years to come.
Nonetheless, the changes can bring significant headroom back into the retirement plans of people who might have previously taken a step back from pensions for fear of breaching these allowances. It also helps to simplify what is often seen as a highly complex area of financial planning.
So, what does this mean going forward?
Whilst the UK media has given significant attention to these changes in the past two months, and they are significant, upon closer examination the reality is more uncertain.
Firstly, since the announcement, the Labour Party immediately announced that they would reverse these changes. With a general election expected in the autumn of 2024, these changes could very well only be in place for a short period of time. Should this be the case, we would expect them to apply some form of protection as they have at times of LTA changes in the past, however at present there has been no comment on this.
The removal of the allowance is also something that might not affect high earners materially for many years. During this period, much can change politically and economically. As seen in the graphic above, the allowance peaked at £1,800,000 before decreasing to £1,000,000 and has grown with inflation since then. It is quite clear, then, that this is an unsettled policy area and one that is vital for us to stay on top of when we are advising our clients.
If you have any questions about the lifetime allowance, have a pension that may have historically breached the lifetime allowance or are unsure what this may mean for your pension fund; then it may be worth getting financial advice or getting in touch with your Financial Adviser.
Please note: Pensions are a long term investment and any income derived from them is not guaranteed, the value of these investments can go down as well as up and you may not get back what you originally invested. The FCA does not regulate tax advice.