The lifetime allowance is a limit on the value of payouts from your pension schemes – whether lump sums or retirement income – that can be made without triggering an extra tax charge. This guide explains the rules and how to protect your allowance.
- How much is the lifetime allowance?
- Charges if you exceed the lifetime allowance
- Individual Protection 2016
- Fixed Protection 2016
How much is the lifetime allowance?
The lifetime allowance for most people is £1,030,000 in the tax year 2018-19.
It applies to the total of all the pensions you have, including the value of pensions promised through any defined benefit schemes you belong to, but excluding your State Pension.
From 6 April 2018, the government intends to index the standard Lifetime Allowance annually in line with the Consumer Prices Index (CPI).
Working out if this applies to you
Every time a payout from your pension schemes starts, its value is compared against your remaining lifetime allowance to see if there is additional tax to pay.
You can work out whether you are likely to be affected by adding up the expected value of your payouts.
You work out the value of pensions differently depending on the type of scheme you are in:
- For defined contribution pension schemes, including all personal pensions, the value of your benefits will be the value of your pension pot used to fund your retirement income and any lump sum.
- For defined benefit pension schemes, you calculate the total value by multiplying your expected annual pension by 20. In addition, you need to add to this 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.
- Whenever you start taking money from your pension, a statement from your scheme should tell you how much of your lifetime allowance you are using up.
- Whether or not you take money from your pension, a check will be made once you reach the age of 75 against any unused funds or undrawn entitlements.
Charges if you exceed the lifetime allowance
If the cumulative value of the payouts from your pension pots, including the value of the payouts from any defined benefit schemes, exceeds the lifetime allowance, there will be tax on the excess – called the lifetime allowance charge.
The way the charge applies depends on whether you receive the money from your pension as a lump sum or as part of regular retirement income.
Lump sums
Any amount over your lifetime allowance that you take as a lump sum is taxed at 55%.
Your pension scheme administrator should deduct the tax and pay it over to HMRC, paying the balance to you.
Income
Any amount over your lifetime allowance that you take as a regular retirement income – for instance by buying an annuity – attracts a lifetime allowance charge of 25%.
This is on top of any tax payable on the income in the usual way.
For defined contribution 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.
For example, suppose someone who pays tax at the higher rate had expected to get £1,000 a year as income but the 25% lifetime allowance charge reduced this to £750 a year.
After Income Tax at 40%, the person would be left with £450 a year.
This means the lifetime allowance charge and Income Tax combined have reduced the income by 55% – the same as the lifetime allowance charge had the benefits been taken as a lump sum instead of income.
For defined benefit pension schemes, your pension scheme might decide to pay the tax on your behalf and recover it from you by reducing your pension.
If you wish to avoid the lifetime allowance charge it’s important to monitor the value of your pensions, and especially the value of changes to any defined benefit pensions as these can be surprisingly large.
You might also wish to consider applying for protection if your pension savings is expected to exceed the lifetime allowance threshold.
Protecting your lifetime allowance
There were and are schemes that allow you to protect your lifetime allowance.
You can check if you already have protection but you will need an account for HM Revenue and Customers (HMRC) online services.
If you don’t have an account you can create one.
If your total pension savings exceeded £1 million on 5 April 2016 there are still two schemes you can apply for – Individual Protection 2016 and Fixed Protection 2016. For more information about how to apply, see below.
Individual Protection 2016
Individual Protection 2016 (IP2016) is only available if the value of your pension savings on 5 April 2016 was over £1 million.
IP2016 is also available to individuals who already have protection under the Enhanced Protection, Fixed Protection 2012, Fixed Protection 2014 or Fixed Protection 2016 schemes.
Use the HMRC lifetime allowance checker
How to apply
You make the application online with HM Revenue & Customs (HMRC).
The online system launched in July 2016 after the new reduced lifetime allowance came into effect.
So anyone applying for IP2016 will need to ensure they do not have a ‘build up’ of pension benefits (i.e. pension accrual) after 5 April 2016.
It’s advisable to speak to your pension administrator for more information and help in applying for IP2016.
There is no application deadline for IP2016.
Level of protection
IP2016 will give you a protected lifetime allowance equal to the value of your pension savings on 5 April 2016 - subject to an overall maximum - of £1.25 million.
The protection rules are complicated. And the ways in which the protection can be lost differ depending on whether your retirement income (including lump sums) is provided from a defined contribution, or a defined benefit pension scheme.
Find out more about how the lifetime allowance works on the GOV.UK website.
You might wish to seek professional financial advice or speak to your pension administrator when deciding whether to apply for protection and working out when and how to take benefits from your pension scheme.
To find out more about the different types of advice available, see our guide Retirement – why should I get advice?
Can you continue saving into a pension?
Yes, you can continue saving into a pension but any pension savings above the protected lifetime allowance will be liable for tax on the excess called the lifetime allowance charge.
Fixed Protection 2016
Availability
There is no minimum pension value required to apply for Fixed Protection 2016 (FP2016).
Unlike IP2016, FP2016 is not available to any individual that holds Primary Protection, Enhanced Protection or Fixed Protection 2012/2014.
Use the HMRC lifetime allowance checker
Level of protection
FP2016 will fix an individual’s lifetime allowance at £1.25 million instead of the new reduced £1 million allowance.
It is possible to lose this protection in certain circumstances. To avoid losing this protection, you must:
- Make sure you opt out of automatic enrolment promptly – you usually have a one month window to do this and get your contribution refunded.
- Not make any further payments into any defined contribution pension scheme after 5 April 2016 – if you do, you’ll automatically lose your protection and revert back to the current limit.
- Think carefully before continuing as an active member of a defined benefits scheme – opting out of active membership and becoming a deferred member significantly reduces the risk of losing your protection. You might wish to discuss your options with a financial adviser.
Can you continue saving into a pension?
No, you will need to stop saving into a pension or accruing benefits from 6 April 2016.
How to apply
FP2016 became available from 6 April 2016. You make the application online with HM Revenue & Customs (HMRC).
The online system launched in July 2016.
It’s advisable to speak to your pension administrator for more information and help in applying for FP2016.
There is no application deadline for FP2016.
This article is provided by the Money Advice Service.