A pension is a valuable asset for retirement planning, providing individuals with the financial security they need to enjoy their golden years without worrying about money.
The UK government offers tax relief on pension contributions as an incentive for individuals to save for retirement. However, there is a limit to how much can be saved in a pension before incurring a tax penalty known as the lifetime allowance.
The lifetime allowance
The lifetime allowance is a cap on the amount of pension savings an individual can accumulate over their lifetime without incurring a tax charge. The current lifetime allowance for the tax year 2022-23 is £1,073,100, and this is set to increase in line with inflation in future years.
When was the lifetime allowance introduced?
The lifetime allowance was introduced in 2006 as part of the government's pension simplification reforms. The aim was to create a simpler, fairer, and more sustainable pensions system that encouraged people to save for retirement.
Before the introduction of the lifetime allowance, there were complex rules around pension contributions and tax relief. Individuals could accumulate large pension pots without incurring any tax charges, which was seen as unfair and unsustainable.
The lifetime allowance ensures that high earners cannot accumulate excessive pension savings without paying their fair share of tax. It also provides a level of certainty for individuals planning their retirement, as they know how much they can save in their pension without incurring any tax penalties.
The lifetime allowance applies to all pension savings, including defined contribution and defined benefit pensions, as well as any additional voluntary contributions (AVCs) and personal pensions. It is also relevant for those with multiple pension plans, as the lifetime allowance applies to the total amount of pension savings an individual has across all their pensions.
If an individual's total pension savings exceed the lifetime allowance, they will incur a tax charge on the excess amount. The rate of tax charged depends on how the excess amount is taken. If the excess amount is taken as a lump sum, it will be subject to a tax charge of 55%. If the excess amount is taken as income, it will be subject to a tax charge of 25% in addition to the individual's marginal income tax rate.
It is worth noting that there are some protections in place for individuals who had already built up large pension pots before the introduction of the lifetime allowance. These protections are known as fixed protection and individual protection and allow individuals to retain a higher lifetime allowance than the standard limit. However, these protections come with certain restrictions, such as a limit on future pension contributions.
It is important for individuals to keep track of their pension savings and monitor their progress towards the lifetime allowance. This can be particularly important for high earners or those with multiple pensions, who may be at risk of exceeding the lifetime allowance. In some cases, it may be beneficial to take action to reduce pension savings, such as by taking benefits earlier or reducing pension contributions.
In conclusion, the lifetime allowance is a cap on the amount of pension savings an individual can accumulate over their lifetime without incurring a tax charge. It was introduced as part of the government's pension simplification reforms and aims to create a fairer and more sustainable pensions system.
It is important for individuals to keep track of their pension savings and monitor their progress towards the lifetime allowance to avoid any unexpected tax charges.
Today, 15.3.23 the lifetime allowance was abolished in the Spring 2023 budget.