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.
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.
You may be interested in: What Is the Tax-Free Allowance for Pensioners in the UK?
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).
You might want to exceed the UK pension lifetime allowance under certain circumstances. We explore them all below:
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.
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:
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.
Related: What Annuity Will 100K Buy?
Note: You must declare this tax payment on your self-assessment tax return form.
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:
Note: You can always contact your pension providers to learn how close you are to your lifetime pension allowance limit in the UK.
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:
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.
You can employ various lifetime allowance strategies to avoid paying or decrease the tax charges incurred by surpassing the limit:
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.
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.
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.
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.
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.
If you die before collecting your pensions, your beneficiaries will be responsible for the tax penalties incurred for exceeding the lifetime limit.
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.