The Lifetime Allowance is the limit on the value of your pension benefits and in the current tax year it’s £1.055 million.
More and more people are being caught by the Lifetime Allowance. According to a survey by Royal London an estimated 1.25 million people can expect to breach it by the time they retire.
The lifetime allowance test only applies when benefits are paid or you reach age 75.
Once a lifetime allowance is breached, you have a choice of how the excess is taxed. Either you can pay 25% tax charge on the excess, plus income tax on any withdrawals you make.
Or, you can take the excess as a lump sum and pay a one off tax charge of 55%.
We all dislike taxes so it’s natural to want to avoid paying this one. We’ve even had someone ask whether they should leave their fund in a current account to avoid it gaining value! Doesn’t sound the best idea.
The fact is that there are pros and cons of exceeding the lifetime allowance and it’s important to look at the particular circumstances.
For example, in our experience clients are quite often higher rate taxpayers when they’re running their business and paying into their pension fund but then reduce to a basic tax rate payer at the time of withdrawal. In which case the effective rate of tax is only 40% and they’ve benefited from tax free compound growth.
Passing Funds on to the Next Generation
If you’re not relying on your pension fund for income in retirement and looking for tax efficient ways of passing on funds to the next generation this might be a real benefit.
If you die before age 75 without having taken any benefits the 25% lifetime allowance charge will apply to the excess and the balance can be paid tax free to any nominated beneficiaries as long as it’s within two years.
And assuming you live beyond age 75, then the 25% lifetime allowance charge will be taken on your 75th birthday and any more growth is exempt from any further test.
Income tax will be payable when the beneficiaries eventually withdraw the funds but this will be at their marginal rate and for grandchildren, as well as children and potentially great grandchildren they might even be non-taxpayers.