We often get asked how does the pension lifetime allowance work.
Put simply, the lifetime allowance is the maximum you can have in all your pension funds.
For the current 2020-21 tax year it’s £1,073,100.
The lifetime allowance (affectionately known as the LTA) was first introduced in April 2006 as £1.50m.
Since then it’s been reduced the last time being in 2016/17 when it dropped to £1 million. It’s been increased in line with inflation every tax year since.
You might have a higher LTA. We’ve seen many changes in pension rules over the years. When that happened people were given the opportunity to register for ‘fixed protection’.
For example, you might have registered for the 2012 version of fixed protection which allowed the £1.8m LTA to be retained.
There’s is an important condition attached to all these fixed protections. Protection is lost if additional contributions are made or any benefits are increased beyond the pension scheme’s normal indexation rules.
So at worst, an extra £1 of pension could see a fixed protected lifetime allowance of £1.8m reduced to the current standard lifetime allowance of £1.073m. Potentially that could create a nasty tax charge!
When is the Lifetime Allowance tested?
There are 13 occasions when the LTA must be tested – this is an HMRC rule.
The most common ones are when you:
- take retirement benefits from your pension scheme;
- reach age 75 and you still have a pension fund
- die and death benefits are payable from your pension fund.
What is the Lifetime Allowance Tax Charge?
If the excess is paid out as a lump sum, the tax charge is 55%. In other words the amount paid out as a lump sum is 45% of the excess.
If the excess stays in the pension fund, the excess has a tax charge of 25%. Any income recevied from the remaining 75% is then subject to income tax.
Who pays the Tax Charge?
If the member is alive when the charge arises, the liability for paying the tax falls jointly on the pension Scheme Administrator and the member.
If the charge arises on death, the person receiving the payment is liable.
The Scheme Administrator deducts the tax charge (normally) before making a payment.
What Can I do to Reduce my Tax?
As you might expect the rules and regulations around this subject are a lot more involved than can be covered in this article.
There are some simple steps that you can take to keep more of your pension fund and pay less in tax.
Contact us to arrange a free discovery call.