When should you start thinking about the pension lifetime allowance?

The pension lifetime allowance (LTA) has been around for 15 years, but the possibility of a potential 55% tax charge on ‘excess’ pension savings still causes confusion and anxiety for many.

The LTA puts a cap on your pension savings, after which there will be a tax cost. The LTA currently stands at £1,073,100 and after the recent budget, this has been frozen until the end of the 2025/26 tax year. This means that more and more people will now face this problem, given that their pension pots benefit from investment growth and compound interest.

Recent calculations from Quilter* suggests that you should start to consider the implications of the LTA once your pension pot is worth more than £500,000 and you are 15 years away from retirement. Younger pension savers should also be aware of LTA planning concerns, with a pension pot of around £250,000 today at risk of breaching the limit in 30 years.

The LTA was designed to affect only the wealthiest 5,000 people when it was introduced in 2006, but 1.25 million non-retired people are now projected to breach the allowance, according to data from Royal London. Many people in their 20s and 30s could well face this tax charge in later life.

As a reminder, the LTA is set by the government and limits the total amount you can build up in pension benefits over your lifetime while still enjoying the full tax benefits. If you exceed the LTA, you will usually pay a tax charge on the excess when you take a lump sum or income from your pension pot, transfer overseas or reach age 75 with unused pension benefits. Any excess may be subject to tax charges of 25% of any income or 55% of any lump sum. This LTA limit applies to the value of all your pension arrangements, including final salary (defined benefit) schemes, personal pensions (defined contribution pensions) and any pension that has paid you a lump sum or income. However, it does not include your State pension.

So, what can you do to avoid or mitigate the effects of the LTA? Stopping pension contributions is not always the best answer. One approach is to adjust your mindset, thinking of the LTA as just another allowance rather than a penalty. It’s not your fault if your fund grows beyond the LTA – in fact, most would regard it as a good thing. It’s simply that there is now relief clawback. The LTA isn’t a set limit and it does not prevent you from making further contributions.

It could also be worth continuing to contribute if your employer pays into your pension but won’t convert that benefit into taxable cash. Logically, it makes sense to have a smaller amount of something than nothing. In this case, there could be other benefits to consider too, such as dependants’ pension or death benefits, that might stop if you withdraw.

Even after you have exceeded the LTA, you should remember that your pension still grows tax free and, assuming that you have available annual allowance, relief is available at your highest marginal tax rate. Your contributions can also still reduce your taxable income below the £100,000 threshold at which your personal allowance is reduced and of course, your pension is protected from inheritance tax.

Obviously, there are other options to consider if you would prefer to stop contributions to avoid a tax charge - for example paying up to £20,000 pa into an Isa, where there is no upper limit on total savings and tax-free income. Venture capital trusts, (VCTs) enterprise investment schemes (EIS) and seed enterprise investment schemes (SEIS) are further options, though these can be higher risk compared to other investments.

With the LTA limit frozen until 2026, more people need to consider LTA pension planning. It is a complicated issue and there are several approaches that you can take, depending on your own personal circumstances. For most people it’s worth getting some financial advice before making a decision, so please do not hesitate to contact us for help.

*quilter pension lifetime allowance warning

The information provided is based on our current understanding of the relevant legislation and regulations and may be subject to alteration as a result of changes in legislation or practice. All references to taxation are based on our understanding of current taxation law and practice and may be affected by future changes in legislation and the individual circumstances of the investor.

Pension investment funds and the income from them may fluctuate and can fall as well as rise. Eventual retirement income will depend on the size and value of your pension pot, future interest rates and tax legislation.

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