“How can I avoid the Lifetime Allowance Charge?”
Following the Chancellor’s decision to freeze the pension lifetime Allowance (LTA) until 2026, many will be wondering whether they will now be caught by this ‘stealth tax’ and if/how they can avoid the LTA Charge.
This short blog will help you to understand:
“What is the pension Lifetime Allowance?”
“How much is the Lifetime Allowance Charge?”
“When do I pay the Lifetime Allowance Charge?”
“How can I reduce the Lifetime Allowance Charge?”
What is the pension Lifetime Allowance?
The LTA is the total amount you’re allowed to build up in your pension before having to pay a penalty tax. The current ‘Standard’ Lifetime Allowance is £1,073,100 (tax years 2021/2022) although some may be eligible for a higher ‘Protected’ Lifetime Allowance (more on this below).
What is the LTA Charge?
The rate of tax you pay on your pension savings above your LTA depends on how you chose to draw the money:
55% if you chose to take it as a lump sum
25% if you chose to draw it as income over time
At first glance, this may seem like a no-brainer, however those choosing the second option will also pay income tax on top of the LTA Charge when they draw down the money.
So for example, a higher rate tax payer will pay 25% initially, then a further 40% (on the remaining 75% that’s left) leaving 45% or the original amount (i.e. 1 x [1- 0.25] x [1 – 0.4] = 0.45) - which amounts to overall tax of 55%.
Therefore the overall tax paid for a higher rate tax payer will be equivalent to the lump sum LTA Charge (for Basic rate tax payers, the overall tax charge is lower, and for Additional rate taxpayers it’s higher).
When does the Charge apply?
Your pension will be tested against your LTA at 13 specific ‘Benefit Crystallization Events’ (BCEs). Not all of these will apply, but the two most common ones are:
When you first start drawing your pension(s)
When you turn 75
If you choose to access your pension(s) in stages, you will be tested for each of these events. You can work out whether you are at risk of incurring a charge by adding up the value of all your pension pots. For defined benefit/final salary schemes, the value is 20 times your pension income plus any lump sum payable.
Even if you are below the threshold when you start drawing you pension (or decide to delay crystalising some of your benefits) you will be tested again at age 75. At this stage, any uncrystalised pension(s) plus any growth on your crystalised pension(s) will be tested against your remaining LTA.
How can I potentially avoid/reduce the Charge?
it may be worth accelerating your income withdrawals before age 75
You may be eligible for a higher Protected Lifetime Allowance (Fixed Protection or Individual Protection 2016) depending on your personal circumstances
Understand whether it’s more tax efficient for you to draw pension as a lump sum or an income
Other points to bear in mind:
Potential implications for inheritance tax planning.
There is an LTA test upon death before 75
There are no LTA tests (or charges) after 75 – so any growth beyond this point is free of tax (including inheritance tax)
Entitlement to Tax Free Cash from your pension is also capped at your LTA
Remember that any investment growth within a pension is tax-free
Get in touch
If you would like help understanding the LTA calculations and the implications for your pension, please get in touch. Our offices are located near Bath, but our clients are primarily based in London, Bristol and the South West. We are happy to have an initial discussion, free of charge, and will, at the very least, try to point you in the right direction.
The pension Lifetime Allowance is a complex area; which course of action is appropriate for you will depend on your individual circumstances.
Please note: This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.
A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits.
The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation and regulation which are subject to change in the future.
