How To Keep From Going Over Your Lifetime Allotment

Jan 04, 2023 By Susan Kelly

In April 2020, the lifetime pension allowance jumped from £1.05 million to £1.0731 million, an increase of £18,100. Although this is encouraging, an increasing number of individuals are withdrawing more than the allowed amount from their pensions, which means they will be subject to a tax of 55%.

The tax rate drops to 25% if the surplus is reported as income. In this article, we'll go through the numerous strategies you may use to shield your pension from the lifetime limit. Despite appearances, many people in their working careers might be on course to exceed the limit without spending another dime, even though £1.0731 million may seem unreachable.

Keep Putting Money Down For Retirement

Rather than discontinuing payments to a pension to avoid a tax penalty, continuing to save is typically recommended. A pension's returns are bolstered by the fact that it grows tax-free, meaning that the investor is exempt from paying Income Tax or Capital Gains Tax on the earnings of the pension as they are invested.

Your company may also cease making pension payments if you stop making them. Paying tax on any surplus above the lifetime allowance might leave you better off financially than giving up any hefty employer contributions.

Get The Most Tax-Free Cash

In addition to a regular income, participants in certain defined benefit pension plans may receive a tax-free lump sum payment. There are a lot of individuals out there who are missing out on tax-free money because they need to be made aware that they may exchange a portion of their pension for cash.

The amount your pension must be lowered to pay for the additional tax-free cash is calculated by dividing the tax-free cash by a commutation factor specified by the pension system. The net result will be a lower value of benefits subject to the lifetime limit test.

This is because the value of the pension is multiplied by a factor of 20 after being decreased, and the total tax-free cash is collected at face value.

Plan For An Early Exit From Your Career

If you start receiving benefits from a defined benefit pension plan before the typical retirement age, your amount may be lower than expected. If you retire early and take a smaller yearly income, the value of your pension may fall below the lifetime allowance, and you will not be subject to the tax on the excess amount.

But in the case of defined contribution pensions, the pension fund's value is measured against the lifetime cap rather than the annuity itself.

The value of the pension fund will be smaller if you begin withdrawing benefits earlier in life than you had originally planned. In this case, if the fund's value is lower than the lifetime limit, no tax will be due on the difference.

Take Your Pension Later Or Leave It

Pension withdrawals are subject to the lifetime allowance once you reach age 75**. Therefore you have the option of delaying them. If you still need to start withdrawing from your pension and reach this age, you may keep your money invested and watch it grow tax-free.

A pension's total value might exceed the allowance without incurring any additional tax liability since it will not be retested. This is helpful if you have other sources of income to support yourself or want to leave your pension to loved ones when you pass away.

Request Fixed or Individual Protection 2016

Fixing Protection 2016 is another option for lowering your lifetime tax bill. You qualify if you have not contributed to a pension fund since April 5, 2016. This equates to a lifetime maximum of £1.25 million. One alternative is to submit a 2016 Individual Protection Application.

If the total value of your pension plans was over £1 million as of April 5, 2016, you are eligible for this. The amount of your pension funds as of that day becomes your lifetime allowance, up to a maximum of £1.25 million.

What If You Exceed The Pension Lifetime Allowance?

If you withdraw funds over your lifetime allowance as a lump sum or as a pension, the tax you owe will vary accordingly. As was previously mentioned, the tax rates are 55% and 25%, respectively, and are paid in a lump sum.

Pensions are taxed at the same rate as salary, so if you intend to withdraw the surplus as a pension, you must account for this additional expense. If additional rate taxpayers take the surplus as a lump payment rather than income, they will pay less tax on the money.

Related Articles