The pensions lifetime allowance - how it works

05 July 2022

Chris Holmes in our London office and Catherine Morgan of Consilio Consulting co-authored “The pensions lifetime allowance”, published by Tax Journal on 17 June 2022.

For more than three decades, successive governments have sought to encourage everyone to save for their retirement, and pensions tax relief has been a critical part of the strategy. However, in acknowledgment that pensions attract exceptionally generous tax reliefs (which cost the exchequer £42.7bn in 2020/21), restrictions have been placed on pension savings. Initially, only annual contributions were capped – currently by way of the annual allowance (AA) – but in 2006, the lifetime allowance (LTA) was introduced, to effectively restrict the total amount a person can save for their retirement tax-free (FA 2004 s 214).

The lifetime allowance (currently £1,073,100) is one of the ways in which tax relief for pension contributions is restricted. On the occasion of a benefit crystallising event, tax will be charged on the amount of the value of a pension fund in excess of the lifetime allowance. The charge will be at 55% if the pension is taken as a lump sum, or at 25% on any excess left in the fund. Various protections have been introduced to enable a person to retain the benefit of old lifetime allowance rates, and a number of options are available to mitigate a charge.

The article includes sections on:

  • How does it work?
  • Protection
  • LTA enhancement factor (LTAEF) for non-residence
  • The LTA charge
  • Qualifying recognised overseas pension schemes

When a benefit crystallising event (BCE) (FA 2004 s 216) occurs for a particular pension, that pension is tested against the LTA. If the value of the pension exceeds the LTA, an LTA charge will apply to the excess. The most common BCEs are on first accessing benefits as a lump sum, annuity or drawdown, on transfer to a QROPS, or at age 75, or on death. When a person accesses a pension for the first time, critically only that pension is tested, but the available LTA is reduced by the value of that pension (FA 2004 s 219). As and when they start to access a second pension, that second pension is tested against the now reduced LTA. We note that in some circumstances it is possible to take a lump sum without accessing the balance of the fund, in which case only the lump sum itself is tested.

Where a person finds themself in a position where their total pension funds have exceeded the LTA or are expected to exceed the LTA by the time they retire, they could:

  • Do nothing and continue to contribute to their pension fund, accepting that there will be an LTA charge in due course;
  • Stop contributing and opt out of occupational schemes, such that only the future growth in the fund will further affect the LTA position. Although more income tax (and possibly NICs) will be payable, some employers will pay additional salary equivalent to their contributions. Furthermore, the net income can be otherwise invested; or
  • For substantial pension pots, a partial or whole transfer to an overseas pension could be an option. Which option they choose is an investment decision, for which it would be prudent to take independent financial advice.

For further information, or for assistance, please contact Chris Holmes.