What is the lifetime allowance?
The lifetime allowance is the total amount you can build up in all your pension savings without incurring a tax charge.
Although there’s no limit on the amount of authorised benefits that can be provided for an individual from their registered pension schemes, there is a limit on the level of tax-privileged benefits. So, effectively, your lifetime allowance determines the amount of benefit you can receive before you have to pay tax on either pension income or lump sums.
The current standard lifetime allowance is £1,055,000.
How to calculate the capital value of your pension benefits
The lifetime allowance is based on the capital value of your pension benefits. There’s a simple calculation you can make to see if you’re likely to be liable for a tax charge. Here’s the formula:
Capital value = lump sum + (annual pension amount x 20)
So, for example, if you’d taken a lump sum of £30,000 and an annual pension was £10,000, the capital value would be:
30,000 + (10,000 x 20 = 200,000) = £230,000
In this case, this level of benefits taken would use up 22.33% of the current standard lifetime allowance.
Of course, if you haven’t yet taken any benefits, it’s harder to judge whether your pension benefits are likely to exceed the lifetime allowance and incur a tax charge.
You can estimate this approximately by applying the basic calculation to the pension amounts shown on your annual statement. SPPA annual statements also show the current percentage of lifetime allowance that your accumulated benefits would equal. We also have pension calculators available here that can help you work out if you’re likely to exceed the standard lifetime allowance.
You should also remember that any other pension arrangements that you have will also be taken into account when calculating your overall lifetime allowance position. This could include private pensions, additional voluntary contributions and any preserved pensions you may have in former employers’ schemes. As a very approximate guide, the following pension amounts would take you up to the current lifetime allowance threshold:
- an annual pension of £51,500 if you don't take a lump sum
- an annual pension of £44,782 if you take the standard tax-free lump sum
- an annual pension of £38,620 if you take the 25 per cent maximum tax-free lump sum.
Exceeding the lifetime allowance
You won’t use any of your lifetime allowance until you start taking benefits from your pension arrangements. When this happens, it’s known as a ‘benefit crystallisation event’ and at each ‘event’ you start to use up your lifetime allowance.
So, for example, if you retire and you receive a lump sum and then regular pension payments, these are classed as two separate ‘benefit crystallisation events’ and each will use up a percentage of your lifetime allowance. Other ‘benefit crystallisation events’ include reaching the age of 75, death and transferring to qualifying recognised overseas pension schemes.
Once you’ve used up all of your lifetime allowance, you’ll have to pay a lifetime allowance charge on any further benefits you take. Effectively, that’s a tax, currently paid at the following rates:
- 25% on pension income
- 55% on lump sums.
If you do have to pay a lifetime allowance charge, it’s deducted by the pension scheme administrator and your benefits are permanently reduced to recover the charge.
Lifetime allowance protections
Since it was first introduced in 2006, the lifetime allowance has varied in different tax years. For example, when it was first introduced, the lifetime allowance was £1.5 million – significantly more than the current level. The variations over the years have led HMRC to introduce a number of ‘protections’ which mean that some people are entitled to a personal lifetime allowance that’s higher than the standard lifetime allowance.
In most cases, the people who qualified for protections had already accumulated pension funds in excess of the lifetime allowance amounts when they were introduced. Although the deadlines to apply for some of these protections have already passed, you may be able to apply for more recent protections if your pension fund value exceeded the lifetime allowance when it was revised in the 2014 and 2016 budgets. You can find out more about applying for protection from the lifetime allowance charge here.
Independent financial advice
If you believe that you are likely to exceed the lifetime allowance limits and are unsure about how this could impact your retirement planning, it’s usually worth taking independent advice from an appropriately qualified financial adviser.