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What is the pension lifetime allowance and how does it work?

Updated 19 January 2021

5min read

Nick Green
Financial Journalist

lifetime allowance

Your lifetime allowance (LTA) is the maximum amount you can draw from pensions (workplace or personal) in your lifetime without paying extra tax. This figure is currently £1,073,100.

Read on to find out more about how this lifetime pension limit may affect you, so you don’t face an unexpected tax charge in 2021.

What is the pension lifetime allowance?

The pension lifetime allowance is best defined as the maximum size you can allow your pension pots to grow to. This limit is currently £1,073,100. However, it changes from time to time – usually getting smaller.

If you have any final salary (defined benefit) pensions, it can be a little more complex to calculate your LTA, as this kind of pension doesn’t involve a fixed pot of money. You can find out more about this below.

The LTA shouldn’t be confused with the annual allowance, which is the amount you can pay into pensions in a single tax year.

How does the pension lifetime allowance work?

If your pensions are collectively worth more than the lifetime allowance, you’ll usually face an extra tax charge. How much this charge is will depend on how much you exceed the limit by, and also how you take your pension (see ‘What happens if my pension exceeds the lifetime allowance?’).

Note that the lifetime allowance is defined as the amount that you can draw out, not pay in to your pensions. This is important, because it takes into account pension pot growth and other factors such as tax relief. This means it is possible to exceed the lifetime allowance by accident. If you suspect your total pension savings are approaching the limit (including any final salary pensions) then seek financial advice to work out how much you can continue to save.

How has the pension lifetime allowance changed?

The pension lifetime allowance has significantly reduced in recent years. Before 2006 there was no limit to how much people could save into pensions. When it was introduced the allowance was £1.5 million, and rose to a peak of £1.8 million by 2012 before starting to fall. It hit a low of £1m in 2016/17 before rising again to its current level of £1,073,100.

What happens if my pension exceeds the lifetime allowance?

If your pension goes above the allowance, your pension provider will let you know in writing. Any extra tax you owe will be deducted from your pension by your provider before you receive the money.

You’ll need to report this tax on your self-assessment tax return.

How much is the tax charge for exceeding the lifetime allowance?

You’ll pay an extra tax charge on the excess amount above your lifetime allowance. For example, if your pension pot totals £1,200,000 then the excess is £126,900. This amount is then taxed at either 55% (if you take it as a lump sum) or 25% if you take it any other way (e.g. through drawdown, UFPLS or buying an annuity). So your additional tax bill would be either £69,795 or £31,725.

When will my pension be tested for the LTA?

You can ask your pension provider at any time to let you know how close you are to your lifetime allowance. If you have more than one pension pot, make sure you contact all your providers (and make sure you have tracked down any forgotten pensions too).

Your provider will let you know in any case when you decide to start drawing your pension.

How can I calculate the value of my pension?

You can ask your pension provider(s) to give you an up-to-date valuation of your pension, but make sure you have tracked down all your current pension pots, as you may have some from early employments that you’ve forgotten about. Also bear in mind that pension value may fluctuate with the stock market – a sudden rise in the markets may benefit your fund, and push you accidentally over the allowance if you are already close to it.

If your pension pots aren’t all with one provider, you may need the help of an IFA to get a reliable valuation.

How do I calculate my LTA if I have final salary pensions?

Calculating the value of final salary (defined benefit) pension for lifetime allowance purposes is slightly more complex. This is because a final salary pension is not a fixed pot of money, but a guaranteed annual income for the rest of your life.

 In most cases, if you know the annual amount of your pension, you can work out its total value by multiplying that figure by 20 (because the average person is expected to live 20 years from the date of starting to draw their pension).

Note that this isn’t the ‘real’ total value of the pension for any other purposes. If you live longer than 20 years, it will pay out more, and if you don’t live that long it will pay out less. Similarly, if you are transferring your pension, its transfer value may well be more than that (though it’s unlikely to be less).

What can I do if my pension is approaching the allowance?

If you’re worried that continuing to save into your pension could cause it to exceed the lifetime allowance, talk to your pension provider and also to an independent financial adviser. Your options may include either opting out of your workplace pension or simply continuing to save and paying the tax charge later. Which option works out the best value for you may depend on your circumstances, so independent advice is important here.

Is it worth going over the allowance?

If you are claiming full higher rate tax relief on your pension contributions (i.e. 40%) then this provides an effective 65% boost in the value of each pension contribution. Depending on a few other circumstances (such as pot growth and any other income tax that is due on your pension income) this may be enough to offset the 25% tax charge. Again, it’s not clear cut and varies from person to person, so speak to an IFA about this.

Can I protect my lifetime allowance?

If your pension savings were above the current lifetime allowance in the tax year 2015/2016, but below the lifetime allowance at that time (£1,250,000) then you can apply for individual protection 2016. This protection means your pension savings will be measured against your lifetime allowance as it was then. Talk to your financial adviser to find out more.

Where can I get advice on how the pension lifetime allowance affects me?

Any independent financial adviser specialising in pensions will be delighted to advise you on issues relating to the lifetime allowance. You can find yours using the tool below.

FAQs

Who pays lifetime allowance charge on death?

If you die before taking your pensions, your beneficiaries will have to pay any tax charge due as a result of exceeding the lifetime allowance.

What happens to my lifetime allowance during a divorce?

If a pension is to be shared between the ex-spouses following a divorce, then the amount each receives will be counted towards their own lifetime allowance. This may be of particular concern to the ex-spouse who was not the original holder of the pension, as if he or she already has pensions of their own, their share of the split pension may push them above the lifetime allowance.

Will the lifetime allowance increase with inflation?

For the past few years the lifetime allowance has increased broadly in line with inflation. However, it has been reduced in the past, so there is no firm link with inflation. The allowance increases or decreases entirely at the government’s discretion.

Will the pension lifetime allowance be scrapped?

There is little sign that the lifetime allowance will ever be abolished, though it didn’t exist prior to April 2006. If you feel that you need retirement savings of more than the allowance, ask your IFA about other tax-efficient ways to save and invest.

Are tax free lump sums included in the lifetime allowance?

Yes – your total pension savings are assessed for the lifetime allowance before you start to draw them. If you have exceeded the allowance, an extra tax charge will be payable. However, tax free lump sums are free of ordinary income tax.

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About the author
Nick Green is a financial journalist writing for Unbiased.co.uk, the site that has helped over 10 million people find financial, business and legal advice. Nick has been writing professionally on money and business topics for over 15 years, and has previously written for leading accountancy firms PKF and BDO.