f you are considering transferring your Final Salary Pension, one thing you should make sure you are aware of is the Lifetime Allowance (LTA) and how it might affect you.
What is the Lifetime Allowance?
The Lifetime Allowance is a limit on the value of payouts from your pension schemes that can be made without triggering an extra tax charge. Your private pension contributions are tax-free up to certain limits. This applies to most private pension schemes, e.g. workplace pensions, personal and stakeholder pensions, and overseas pension schemes that qualify for UK tax relief. However, if your pension pot is worth more than the lifetime allowance you will pay additional tax on it. If you go over the limit you’ll be taxed whether you take your pension as lump sums or retirement income.
How much is the Lifetime Allowance in 2018?
The LTA was reduced from £1.25m down to £1m from 6 April 2016 but since April 2018 it has risen to £1,030,000. The Government has indicated that this allowance will increase each year in line with inflation (CPI).
If you have more than £1.03 m in your pension pot, accrued before April 2016, you can apply to protect it against these reductions to the Lifetime Allowance. Full details can be found on the government website.
Defined Benefit and Lifetime allowance
For those drawing a defined benefit (final salary pension) above the LTA, without any protection, the rate of tax you pay on pension savings above your lifetime allowance depends on how the money is paid to you.
Current taxable rate over the LTA
- 55% if you get it as a lump sum
- 25% if you get it any other way, for example, pension payments or cash withdrawals
This is on top of any tax payable on the income in the usual way.
LTA Income Examples
Suppose you pay tax at the higher rate and expect to get £1,000 a year as income. The 25% lifetime allowance charge will reduce this to £750 a year. After Income Tax at 40%, you would be left with £450 a year.
This means the lifetime allowance charge and Income Tax combined will have reduced your income by 55% – the same as the lifetime allowance charge had the benefits been taken as a lump sum instead of income.
How and when do I pay Lifetime Allowance tax
For defined benefit pension schemes, your pension scheme administrator should pay the 25% tax to HMRC out of your pension pot, leaving you with the remaining 75% to use towards your retirement income. This will be collected at source by the pension scheme from day one of the pension payments.
Those with Defined Contribution accounts valued at more than £1.03m (or higher with protection) can defer the impact of the lifetime allowance to age 75.
This can be achieved by keeping drawings within the LTA limits up to age 75 and gaining the benefit of a largely tax-exempt investment account until that date when the surcharge tax will become due on the excess value of the fund – 55% if taken as a lump sum or 25% tax if taken as income.
If you have no need for the funds in excess of the LTA then you could consider leaving these invested in your pension. Although you have to pay the LTA charge of 25% at age 75, the funds will remain outside of your estate. If you die after your 75th birthday your ultimate beneficiaries will have to pay income tax on the benefits but this may be preferable to you paying income tax on the income and inheritance tax (currently 40%) on any funds that remain in your estate.
Does this apply to me?
You can work out whether you are likely to be affected by the Lifetime Allowance by adding up the expected value of your pension payouts:
For defined benefit pension schemes, calculate the total value by multiplying your expected annual pension by 20.
You’ll also need to add the amount of any tax-free cash lump sum if it is additional to the pension. In many schemes, you would only get a lump sum by giving up some pension, in which case the value of the full pension captures the full value of your payouts.
So you are likely to be affected by the lifetime allowance in 2018-19 if you are on track for a final salary pension (with no separate lump sum) of more than £51,500 a year.
Note that certain tax-free lump sum benefits paid out to your survivors if you die before age 75 also use up lifetime allowance.
Source: Money Advice Service
When paying more into your pension might not make sense
From April 2016 income tax relief on pension contributions has being tapered from £40,000 per year for anyone with total earnings of less than £150,000 down to £10,000 per year for those with earnings over £210,000.
If you are over your LTA this could mean you will pay 45% tax on your deemed contribution to a scheme which will generate no further tax-free cash and only pension income taxed at 55% or more.
Some employers are now offering salary enhancements to members who opt out of defined benefits schemes who will be caught by these changes. Check with your pension administrators if this applies to you.
What to do if you’re over the Lifetime Allowance
If you do find yourself over your Lifetime Allowance, or you think you’re going to be, it is worth speaking to your financial advisor to discuss alternative tax-efficient savings. If you accrued your Pension before April 2016, depending on your circumstances, you may be able to apply for protection against the changes up to £1.25 million. See the government website for details.
Final Salary Pension Transfer
If you’re considering a Final Salary Pension Transfer it is always worth seeking financial advice from a qualified Pension Transfer Specialist. If you don’t know where to start our Definitive Guide to Final Salary Pension Transfer should point you in the right direction