The Lifetime Allowance (LTA) was introduced in 2006 as the capital limit on your tax-efficient pension benefits. Benefits in excess of the Lifetime Allowance will be subject to a ‘Lifetime Allowance Charge’.
How has it changed, and what is the impact of the Budget?
The big change recently is that the LTA will no longer receive inflationary increases until 2026. While this announcement may not create an immediate tax charge, it may cause many more people to exceed the LTA in the future.
How is it paid?
The LTA is levied at 55% on lump sums and 25% on payments in any other way (for example pension payments or cash withdrawals).
There is a joint and several liability for a lifetime allowance charge between the scheme administrator and the member. The LTA tax charge arises on a ‘benefits crystallisation event’, which usually requires some action by the individual beneficiary (for example to designate funds for drawdown, or to take an annuity). It is the scheme administrator who must determine whether a charge arises on a benefit crystallisation event, and the responsibility for paying the charge is a joint one (although in cases of death benefit, or where there is a payment to a dependent or beneficiary, the liability can pass to the recipient). Where the liability is paid from the scheme (by the scheme administrator), this will reduce the assets in the scheme available to pay benefits at a future date.
- The tax is paid by the last pension to cross the LTA threshold on a benefits crystallisation event, so it is vital that you take your pensions in the right order.
- If the LTA charge arises on death then it is the beneficiary of the pension that is liable to the charge, not the estate of the member.
- Having an LTA doesn’t necessarily mean you should stop contributing to schemes as there may be future valuable benefits available, so it will be important to take appropriate advice in this area.
What if I have taken benefits from my pension already?
When you take benefits from your pension, they use up a percentage of the LTA at that time. For example, if you took £150,000 of benefits back when the Lifetime Allowance was £1.5million, this would have used 10% of your Lifetime Allowance. You should therefore have 90% of the current LTA remaining today (90% of £1,073,100 = £965,790).
Who could be affected by the Lifetime Allowance freeze?
Anyone whose benefits could increase above £1million could be affected. This includes:
- Those who are younger than 75 have taken benefits already.
- Anyone age 50 and above.
- Anyone with a mix of defined benefit and defined contribution pensions.
- Anyone who has already applied for LTA protection.
- Those earlier in their careers making significant pension contributions.
What can I do?
There are ways that you can reduce your LTA tax liabilities, but there is no one-size-fits-all solution. The right course of action depends on your circumstances and the type of pensions you have. Some options could include:
- Protecting your LTA at a higher level, if you meet the right criteria.
- Taking benefits earlier than planned.
- Changing the way you take your benefits, e.g. taking more/less tax-free cash.
- Changing the order you take your pensions – this can have a significant impact.
- Changing your contributions and saving through non-pension savings: Examples could include ISAs, General Investment Accounts, Enterprise Investment Schemes, Venture Capital Trusts, etc. In addition to investment considerations, there may be other tax issues to take into account than just the LTA.
What are the implications of going over the LTA?
The pension scheme will normally pay a tax charge on your behalf. It will then reduce the benefits in payment to you. The tax charge to pay will depend if the benefits crystallisation event is the withdrawal of a lump sum (a 55% charge) or otherwise (a 25% charge).
How are pensions valued?
Defined Contribution pensions (e.g. pot of invested money) are the easiest to value – it is just the value of the underlying investments. E.g. £100k of defined contribution pension investments represents £100k against of the LTA.
Defined Benefit schemes (Final Salary/Career Average/Scheme Pensions such as the NHS Pension Scheme), which offer a promise of income from a certain age are valued as 20x the income payable, plus any tax-free cash. For example, if a pension paid £10k per annum plus a £30k tax-free lump sum on retirement, this would be valued as £10k x 20 + £30k = £230k.
- The LTA value of a defined benefit pension is not the same as the transfer value. If you are considering the transfer of a defined benefit pension, then you may also be increasing its Lifetime Allowance value.
- State pensions do not count towards the Lifetime Allowance.
When is it applied?
Whatever happens, your pensions will be tested against the LTA. If you use drawdown, your benefits will be tested twice, first when you access them and then at the of age 75 or earlier death. It is vital then that you continue monitoring your pensions against the LTA and plan your income accordingly.
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