April 22nd, 2020

Pension advice: lifetime allowance charge examples

Have you been scouring the web for lifetime allowance tax examples? Here’s a short guide that will set you straight on an important aspect of personal pensions that often leaves savers confused.

You already know that it’s important to save for your future. But putting too much into your pension schemes can result in some sizeable tax charges. It’s all down to the rules surrounding lifetime allowance.

To help you save efficiently for your retirement – and retain more of what’s yours – here’s a quick explainer on lifetime allowance, with some lifetime allowance charge examples for good measure.   

How much is the lifetime allowance?

The lifetime allowance for the 2020-2021 tax year is capped at £1,073,100. This cap applies to the total value of all your pension schemes – excluding your state pension. Any pension savings you have beyond that cap will incur additional tax charges.

A word on defined contribution vs defined benefit

Let’s quickly compare these two different pension schemes in the context of your lifetime allowance.

If you have a defined contribution scheme, the value of your pension will be the value of your pension pot used to fund your retirement income as well as any lump sum.

For defined benefit schemes, the value of your pension is calculated by multiplying your expected annual pension by 20. Make sure you add any tax-free cash lump sum if it is additional to your pension.

When you begin taking money from your pension, your scheme provider should give you a statement to show you how much of your lifetime allowance you are using up.

Lifetime allowance charge examples

If the amount you draw from your pension exceeds the lifetime allowance threshold, you will have to pay additional tax on the excess. The fee you will be charged depends on whether you are taking a lump sum from your pension or using it for regular retirement income.

Lump sums will be taxed at 55%, while regular income will be charged at 25%. Note that this is on top of any regular tax payable on your pension income. That’s why it’s so important to stay within the lifetime allowance threshold.

Here’s an example. Let’s imagine that you have a single defined contribution pension, with a total value of £1,250,000. That exceeds the 2020/2021 lifetime allowance by £176,900 – and this excess amount will be subject to the additional tax charges.

Or if you had a defined contribution pension value of £1,500,000, you will be over the lifetime allowance by £426,900. As you can see, saving too much into your pension can see large amounts of your wealth wiped out with tax liabilities. The more you overstep the mark, the more damage it does to your future wealth.

Have you already utilised part of your pension?

The lifetime allowance changes each tax year. If you have already been drawing your pension for several years, your tax liabilities will need to be calculated based on what the lifetime allowance was in each of the tax years that you drew from your pension. It can get a little complicated but it’s important to know where you stand in order to make sure your money is going as far as possible. A good financial adviser will be able to go through everything with you.  

What happens if you die before taking your pension?

Your pension can be passed on to your beneficiaries. But only if you die before the age of 75 and haven’t started drawing from your pension. The lifetime allowance charges apply as normal.

Make your money work harder for your future

You deserve a safe and comfortable retirement. That’s why it’s important to make sure your money is working as hard as possible for your future. The tax implications of exceeding the lifetime allowance threshold can make a serious dent in your wealth, so it’s worth finding alternative ways to invest any excess once your pension contributions have reached a certain value.

Here at Financial Solutions, our independent financial advisers have helped thousands of people plot a smart roadmap towards a secure financial future. If you would like to find out more about how we could help you stay in line with the lifetime allowance and make your wealth go further, get in touch for an informal conversation.