How well do you understand the Lifetime Allowance tax charge?
The lifetime tax allowance (LTA) is the maximum amount of pension savings which you can access tax efficiently in your lifetime. Prior to 2006 there was no limit to the amount you could save. The first lifetime allowance was set at £1.5m.
It rose to a peak of £1.8m for the 2010/11 tax year but has steadily dropped since as successive Governments have raided pensions to fund other projects. You can now save up to £1,073,100 into a pension over your lifetime.
We get a lot of clients & prospective clients asking how this allowance will affect them, so we thought we would set the record straight. Below are the most common myths we hear.
1. 'I must stop pension contributions when the LTA limit is reached'.
Allowance is the keyword, there is not a limit to funding as many people seem to think. There is nothing to prevent individuals from continuing to pay into pension pots. The LTA is not the barrier to pension savings or growing investments, it's the point where you should look at the tax treatment of what this additional fund will ultimately mean. This allowance is no different to any other, such as personal income tax allowance, annual capital gains tax allowance, or the dividend allowance.
2. 'I will pay a tax charge as soon as I am over the LTA limit'.
There is no immediate charge, the tax charge is incurred when benefits are crystallised- such as when the fund is designated to drawdown. The charge is also incurred on access, death, or at the age of 75.
3. 'The LTA tax charge is applied when you start to take benefits'.
The charge begins when there's not enough LTA to cover the fund that is being crystallised. Each time you crystallise part of your pension, a percentage of the LTA is used, the charge itself only comes into play when there's no longer enough LTA available to cover the amount being crystallised. By phasing retirement and only crystallising enough funds which are needed each year, means the timing of the LTA charge can be managed, at least up to the age of 75. At the age of 75 the uncrystallised funds will be tested along with any investment growth on crystallised funds.
4. '55% is the tax charge for exceeding limits'.
This charge is payable if the whole chargeable amount is taken as a lump sum. If you move funds into your drawdown pot, only 25% will be deducted.
5. 'My whole pension pot will be charged'.
People fear the lifetime allowance, savers must remember the charge is only applied to the excess savings above the lifetime allowance- not the whole pension fund.
6. 'The pension scheme/ employer will pay the tax charge'.
This should not be counted on. HMRC state that the pension scheme and the pension member are jointly and severally liable, and if the scheme is unaware of liability or is provided incorrect information, the liability falls on the member to pay the charge via their self- assessment for tax.
It cannot be stressed enough how important regular advice can be in this situation. A wrong or rash decision could lead in an unnecessary level of paid tax. Potential strategies can be used to limit the tax charge that is paid. Don't fear the lifetime allowance, with careful planning there are potential strategies you can use to manage the tax charge.
The articles are for information only and should not be construed as advice or a recommendation. The investment strategies mentioned are examples only and may not be suitable for your particular: circumstances, tax position or objectives. Please seek independent financial advice before taking any action.
Names have been changed to protect identity.
No advice should be conferred from the articles. No action should be taken without independent professional financial advice as any actions on your pension may be irrevocable and have a big impact on your income in retirement.