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Is It Worth Exceeding the Lifetime Allowance in the UK

Written by, Marija Petkova

Updated May, 31, 2022

Most UK residents are unaware that if their pension savings exceed a set lifetime allowance, they will have to pay additional tax charges on the excess amount.

So, how much money can you save exactly before paying additional tax fees, and is it worth exceeding the lifetime allowance?

Keep on reading to learn more about UK’s pension LTA rules and how they affect you.

What Is the Lifetime Allowance?

The lifetime allowance is the maximum amount you can accumulate in pension benefits over your working life while still receiving UK’s tax benefits. If and when you go beyond this limit, you’ll usually have to pay a penalty on the excess, typically deducted from your pension.

The UK Pension Lifetime Allowance for 2021/22

The current LTA limit for the majority of UK citizens is £1,073,100 and will remain frozen at this level for four consecutive years.

The LTA affects the total value of all your pensions, including defined benefit schemes and contribution pensions (excluding the state pension).

Is It Worth Exceeding the Lifetime Allowance?

You might want to exceed the UK pension lifetime allowance under certain circumstances. We explore them all below:

  • Contributing to your workplace pension to receive an employer-matched contribution—although you will be charged with a 25% lifetime allowance tax, you will receive a 100% return on your contribution;
  • Contributing to a pension to avoid a future inheritance tax bill—as pensions are not part of your estate, you will not be taxed on them; thus, you’ll incur a 25% tax charge instead of the 40% inheritance tax charge. However, keep in mind that there is a 7-year inheritance tax rule that may be of benefit;
  • Contributing to a defined benefit pension—you earn a considerable income from these important pensions, so the money you earn is typically worth considerably more than any tax liability that might be incurred.

Note: Some UK employees also surpass their LTA pension limits if they claim the higher rate tax relief on their contributions in excess of 40%, as it might offset the 25% tax.

What Is the UK Pension Lifetime Allowance Tax Charge?

The applicable lifetime allowance tax charge varies based on the money withdrawal method, and below, we review two scenarios for the 2022/23 tax year with a £1,073,100 LTA limit:

  • 25% if taken as an income—you pay lower taxes if you arrange an annuity or take a regular monthly income via drawdown.
  • 55% if taken as a lump sum—if you take the extra as a lump sum, it will be taxed at 55% and paid out to HMRC.

For instance, if your current pension pot amounts to £1,500,000, you would be £426,900 over the LTA limit. So if you take this amount as a lump sum, you would have to pay £234,795 in taxes, but only £106,725 if you withdraw it as an annuity.

Note: You must declare this tax payment on your self-assessment tax return form.

When Does the Lifetime Allowance Test Apply?

Your pension LTA is checked occasionally and for different ‘benefit crystallisation events (BCEs)’ to determine if it exceeds the current year’s limits. For instance, yours will be checked when:

  • You start withdrawing from a defined benefit pension;
  • You transfer a pension to a different country before age 7%;
  • You take out a lump sum from a contribution pension;
  • You turn 75 years of age and haven’t yet drawn from your pension, etc.

Note: You can always contact your pension providers to learn how close you are to your lifetime pension allowance limit in the UK.

Protecting Against the Lifetime Allowance Charges

If you are approaching the LTA limit and would like to avoid the standard tax charges, you can apply for the pension lifetime allowance protection in one of two ways:

  • Individual Protection 2016—offers you a personalised LTA equivalent to your pensions’ value on the 5th of April, 2016 (if they were worth at least £1 million), and the cap would be £1.25 million;
  • Fixed Protection 2016—fixes your LTA limits at £1.25 million, but you cannot utilise it if you made any contributions past the 5th of April, 2016.

Note: To understand the limitations of these protection strategies and whether or not you can apply for either of them, consult with a financial adviser or contact your pension provider.

How to Avoid the Pension Lifetime Allowance Charge?

You can employ various lifetime allowance strategies to avoid paying or decrease the tax charges incurred by surpassing the limit:

  • Pay into your ISA allowance—instead of filling your pension pot, you can redirect your funds to an ISA to benefit from a similar tax-free growth;
  • Retire earlier than expected—if you can take your pension before the set age and you have accrued enough for your golden years, avoid the tax by retiring early;
  • Take advantage of employer contributions— if you have a generous employer who contributes significantly more than the average, take the offer and exceed the limit;
  • Contribute to your spouse’s pension—take advantage of one of your marriage tax benefits and redirect your contributions to your spouse’s pension plan.

Note: Pension advisers might also suggest certain unconventional methods of making the most of your contributions, such as investing in a flexible pension and withdrawing tax-free cash.

Bottom Line

Consider the current LTA limit in the UK, especially when nearing retirement, to ensure you are well off during your golden years. Ultimately, your current circumstances and life goals should help you choose the best lifetime allowance strategies with regards to your pension.

Frequently Asked Questions And Their Answers

Will the pension lifetime allowance be scrapped?

As of now, there’s no indication that it will be phased out. However, in 2021, the UK government froze the current LTA limits until 2026.

Will the lifetime allowance increase?

While the pension LTA has steadily risen for several years, it has been decreasing before that. Mainly, the LTA limits follow inflation trends and the government’s economic policies.

Does taking tax-free cash affect the lifetime allowance?

Withdrawing tax-free cash from your pension is a valid strategy to avoid hitting the LTA limit. However, in such cases, your pension will not grow as much.

Who pays the lifetime allowance charge on death?

If you die before collecting your pensions, your beneficiaries will be responsible for the tax penalties incurred for exceeding the lifetime limit.

Is it worth exceeding the lifetime allowance?

It depends on your current circumstances and whether or not you can minimise the applicable tax charges. For instance, you might benefit from surpassing the limit if you are receiving substantial employer contributions or trying to avoid the higher inheritance tax.

My name is Marija, and I'm a financial writer at DontDisappointMe. Although finance might not be everyone's cup of tea, my 10+ years of working in one of the biggest banks in my country, and my interest in extensive research on everything finance/investment-related, have made me somewhat of an expert in the field (if I do say so myself). No longer having the passion to work in a corporate setting, I decided that I couldn't let all of this knowledge go to waste so I started writing. And, here I am! Today I try to share my knowledge with my audience in the hopes of making this topic as simple and interesting as possible. In my leisure time, I like spending time with my family and travelling to new locations.