When you’re in the middle of your working life, the idea of reaching the pension Lifetime Allowance (LTA) can seem unthinkable, especially when you have a defined contribution (DC) pension.
For the 2021/22 tax year, the standard LTA is £1,073,100. As a result, it can feel a distant threshold as you make contributions into your retirement pot.
But as you work and save over the years, a combination of your contributions, tax relief, and investment returns could slowly see you creep towards the LTA threshold.
This is particularly true if you have a high salary, as the percentage of your wealth that you save into your pension pot could, over time, drive you toward the threshold quicker than you might think.
That’s why it can be useful to be aware of the LTA sooner rather than later. That way, you can employ strategies that ensure you can deal with any issues that arise.
The LTA is the maximum amount you can save tax-efficiently
Simply put, the LTA is the maximum amount of money you can hold across all your pension schemes without triggering an additional tax charge.
You won’t be taxed on your retirement savings while they accumulate. But, if your pensions are over the LTA when you come to draw from your pots, HMRC will issue a tax bill to recoup the tax relief they gave you.
Taking money from a pension over the LTA as income could see you charged 25% tax, on top of your marginal rate of Income Tax. Meanwhile, if you take a lump sum, you may face a 55% tax bill.
Even with investment returns and tax relief, these tax charges could severely reduce the amount you have to live off in retirement. That’s why it’s an important metric to keep an eye on.
Rishi Sunak froze the LTA in the spring Budget
The LTA has changed a fair amount over the years. It reached its highest level of £1,800,000 in the 2011/12 tax year, but dropped down to just £1,000,000 in 2016/2017.
Since then, it has steadily risen each tax year, usually in line with the Consumer Price Index (CPI).
However, in the 2021/22 tax year, the threshold was frozen to 2026 in Rishi Sunak’s spring Budget. This is part of the chancellor’s plans to help balance the public purse after hefty public spending on Covid recovery measures.
According to This Is Money, estimates show that this could save the government £250 million a year in tax over the next three years.
This freeze may seem inconsequential, but it may mean you’re pushed over the limit when you reach retirement, especially if you’re planning to retire soon.
What to do to avoid breaching the LTA
There are a number of different strategies you could employ if you’re concerned that you’re going to breach the LTA.
Reduce your pension contributions
The first option you could consider for staying under the LTA is to reduce your pension contributions.
By cutting down how much you’re putting in, you may be able to slow the growth of your pot. However, this will also reduce tax relief and the amount of investment returns you receive.
Make sure you can afford to do this before you make any changes as it may affect your retirement lifestyle.
Put your retirement money elsewhere
If you can’t or don’t want to reduce your pension contributions, your next step may be to find alternative homes for your retirement funds.
For example, you may want to consider investing via a Stocks and Shares ISA, giving you tax-efficient returns free from Income Tax and Capital Gains Tax (CGT). Investing this way can provide you with a return while avoiding tax charges.
You could also think about fixed-rate savings accounts to ensure you receive a return on your money while also keeping it safe and away from the investment markets.
Think about retiring sooner
If you’re getting towards retirement and you think your pots will exceed the LTA, you could consider retiring sooner than you had planned.
By retiring sooner, you can start drawing from your pot. This means you can directly reduce the value by taking money out.
You’ll also typically stop making contributions at retirement, so you’ll no longer have to worry about tax relief. This means the only growth you need to be concerned about is any generated investment return.
It’s particularly important to check that you’ll be able to afford this strategy. You will probably need enough money to support yourself for a few more years of retirement than you may have accounted for.
Take your pension as income, rather than a lump sum
One option you could consider if you’re going to exceed the LTA is to take your pension as income and simply accept the associated tax charges.
If you stop contributing to your pension entirely, you’ll lose the benefits of employer contributions (if you’re in a workplace scheme), tax relief, and investment growth.
In total, these benefits will still likely provide you with more money in your pot than if you hadn’t put it in. Even if you do ultimately pay the 25% tax bill, you may have benefited from higher- or additional-rate tax relief on your contributions during your working life.
As a result, it could make more financial sense to exceed the LTA and pay the charges when you come to draw an income.
Bear in mind you may still have to pay Income Tax on your withdrawals, depending on how much retirement income you have in total.
Apply for LTA protection
You may be able to slightly increase your LTA threshold using either individual or fixed LTA protection if you meet certain criteria.
LTA protection came in after the government reduced the LTA to £1 million in the 2016/17 tax year.
Individual protection increases your personal LTA to either £1.25 million or the value of your pension savings as of 5 April 2016, whichever is lower. You can continue paying into your pot, but you will have to pay tax charges on any money you withdraw that exceeds your protected LTA.
Alternatively, fixed protection allows you to fix your LTA at £1.25 million. Bear in mind that fixed protection means you can no longer continue building your pension savings. If you do, you’ll lose your fixed protection and you’ll have to pay tax on any money you withdraw over the standard LTA of £1,073,100.
Take financial advice
If you’re approaching the LTA and you need help deciding what you should do about it, the best place to start is with professional financial advice.
A financial planner can give you personalised advice that takes your circumstances and goals into account, giving you the confidence that you’ll have enough money in retirement.
Work with us
If you have a particularly large pension pot and you’re concerned that you might exceed the LTA before you retire, please get in touch.
At Bowmore Financial Planning, we have years of experience in helping clients find strategies that mitigate their tax position. We can find the methods that make sure the money you have goes towards living the retirement you want.
Email email@example.com or call 01275 462 469 to speak to us.
The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Levels, bases of and reliefs from taxation may be subject to change and their value depends on the individual circumstances of the investor.
Workplace pensions are regulated by The Pension Regulator.
Bowmore Financial Planning Ltd is authorised and regulated by the FCA