If you’re diligently saving for your retirement, you might be closer to the Lifetime Allowance than you think. Crossing the limit could mean you face extra charges and may mean other saving vehicles would be a better option for you.
What is the Lifetime Allowance?
The Lifetime Allowance is a limit on the total value of pension benefits per individual that can be paid without additional taxes being charged. It’s currently set at £1.03 million.
The Lifetime Allowance covers all the pensions you have and is based on the value of the pension, not your contributions. This means that employer contributions, tax relief and investment returns will also be included.
If you have a Defined Benefit (DB) pension, the value is calculated by multiplying your expected annual pension income by 20.
What happens if your pension value goes above £1.03 million?
If you go above the Lifetime Allowance, you will face additional charges on the amount that crosses the threshold. The amount of tax you pay will depend on how you take the money from your pension. A lump sum over the Lifetime Allowance is taxed at 55%, while a regular retirement income is charged at 25%.
In some cases, this may mean that continuing to pay into a pension isn’t the most efficient option for you. However, in some circumstances, it is still an effective way to continue saving for retirement. It will depend on your personal circumstances and pension scheme. If you’re unsure if you should continue paying into a pension if you’re approaching the Lifetime Allowance, please contact us for tailored advice.
The Lifetime Allowance can seem high but it’s easier than you might think to breach it.
When you consider that you’ll probably be investing in your pension in excess of 30 years, contributions can add up to more than you expect. Once you start factoring in compounding growth, investment returns, tax relief and employer contributions your pension may have grown quicker than you thought.
Approaching the Lifetime Allowance
As we’ve already mentioned, sometimes it can be beneficial to continue paying into a pension scheme, even if you’re going to breach the Lifetime Allowance. For example, if you’re a member of a Defined Benefit scheme with valuable other perks you want to take advantage.
However, you should still be aware of how your pension is growing and the options available if you want to limit tax liability.
Keep an eye on your pension growth
If you’re worried about the Lifetime Allowance and potential charges, the first step you should take is to monitor the value of your pensions. As the value of pensions can fluctuate, it can be difficult to project how they will change, so regular monitoring can help here.
To get a better understanding of how the value of your pensions are likely to change between now and your retirement, please contact us. Using cashflow modelling techniques, we’ll help you see how your pension value can change based on a range of different scenarios. It can give you the information needed to decide if you should take further action.
This is a step that becomes more important as you approach retirement. Remember to include the value of all your pensions to ensure you have an accurate figure.
If you decide to take action to avoid exceeding the Lifetime Allowance, there are several steps you can take.
If you’re approaching the Lifetime Allowance the most obvious way to avoid breaching it is to stop contributing to your pension.
With this option, you do need to be aware that it’s still possible for you to cross the Lifetime Allowance threshold. If your pension is invested, for example, returns could push you over the limit even after you stop making contributions.
There are other ways to save with your retirement in mind. Using your Individual Savings Account (ISA) allowance is often a good place to start if you’re not already contributing the maximum. While you won’t receive the same tax relief, the money taken out of an ISA is tax-free, making it an efficient way to save. Each year you can place up to £20,000 into Cash or Stocks and Shares ISAs.
Other options you may want to consider include using a Venture Capital Trust (VCT) or Enterprise Investment Schemes (EIS) if you’re willing to take on higher levels of investment risk.
Take your pension early
Usually, you can access your pensions from the age of 55; more than a decade before the State Pension age. Depending on your lifestyle and work aspirations, withdrawing from your pension early may be an attractive option.
This is a strategy that can work if you have either a DB or Defined Contribution (DC) pension scheme. However, it means the level of income you’ll receive from a DB will be reduced, as will the amount you can sustainably withdraw from a DC scheme annually.
If you’re still earning an income, you will need to consider how taking an income from your pension sooner will affect other tax liabilities.
Change your investment goals
If you have a DC pension, you will be able to choose a risk profile that suits your investment attitude. Generally speaking, the greater the level of risk you’re willing to take, the higher the potential returns. If you’ve been taking a riskier approach to investing your pension and you’re approaching the Lifetime Allowance, now may be the time to change the level of risk your pension is exposed to.
Choosing a more cautious portfolio in terms of risk could mean that your pension grows at a slower pace. Of course, there’s no way to guarantee how your investments will perform.
If you’d like to discuss how your pension is growing, including concerns around the Lifetime Allowance, please contact us. We’ll look at your personal circumstances, finances and life goals to find you the right option for you moving forward.