What is the allowance and who needs to worry about it?
For most people if their pension pots are worth more than the lifetime allowance it will generate a tax on the excess – called the lifetime allowance charge.
The lifetime allowance is currently (tax year 2019/20) a total of £1,055,000.
That may seem like a lot of money to have in pensions, but it is quite modest in some ways, when you think of how much income may need to be generated across a multi-decade retirement.
The total figure, currently £1,055,000 will increase year on year (it is ‘indexed’).
It is worth noting that the total is not always going to be based on an actual value of a pension, because some types of pension don’t have a straightforward value, as the pension plan maybe be a Defined Benefits pension, which is an annual pension paid based on a formula related to length of service and salary.
Those types of pensions have no actual ‘value’ in terms of a cash figure, so they have to be converted to a cash figure by multiplying the expected annual pension by 20. In addition, add to this the amount of any tax-free cash lump sum if it is additional to the pension.
If there is an excess over the lifetime allowance, the charge is applied and this would be 55% on any amount taken as a lump sum and 25% on any income – above the allowance.
We have provided the most simple explanation we can in those words above, but suffice to say this is a complex position and is riddled with anomalies and things to be wary about. This is why we include this in the 24 areas where advice is pretty much a necessity.
In respect of who needs to worry about this, you may well feel that you are not going to be affected by the allowance, and therefore the charge.
HOWEVER, you need to be very careful making this assumption, for a couple of stand-out reasons above others. One, if you have a defined benefit pension, you may not regard it as being particularly valuable however the formula for converting it to a cash figure can change this. A £50,000 per year pension would come in at £1,000,000 ignoring any additional tax free sum.
Second, the accrual of pension value may well be very much higher than the increase in the future of the Lifetime Allowance. In other words you may be under at 50, but projected to be over at 60.
Also, the lifetime allowance relates to the combined value of all your pensions, with some small exceptions, so the total value across various schemes you may have could add up to the total or above it.
It is for these reasons that more people than one may first imagine will be caught by this allowance and need to take measures to deal with it.
In the context of anyone who is either definitely threatened by the lifetime allowance charge or may possibly move towards it, it is essential to take financial planning steps to manage this.
The obvious way to avoid the charge would be to reduce the value of the pensions, maybe by stopping or reducing contributions. However this could be a false economy. The tax relief on pension contributions could – in certain circumstances – be more valuable than the future charge on any excess against the allowance. This is therefore far from straightforward.
Even where it is deemed sensible to take ‘evasive’ action, how to do so needs careful appraisal, especially where there are multiple pension pots.
This is not an article to delve into the finer details, more to bring to the fore the complexity of this position and the need for expert help where this starts to impact upon on an individual’s finances or their future outlook.
If you consider you have a looming Lifetime Allowance issue then seeking expert advice makes perfect sense.