The financial planning journal

£700,000 in your pension? The lifetime allowance could mean you are being taxed at 55%

6 July 2021

If your pension pot is becoming a sizeable asset, it might not be long until you could be taxed at a painstaking 55%. The lifetime allowance or ‘LTA’ is essentially a cap on the size of your pension. The current limit is £1,073,100. Go over this and your money could suffer significant tax penalties. This amount includes any contributions you make to your pension, as well as the growth of your fund, and is applied across both defined benefit schemes and more typical defined contribution pensions.

Fortunately, the tax penalties will only apply when you come to take the money out, however, they are pretty steep. This complicates further at age 75 but that’s for another article.

What are the lifetime allowance tax charges?

If you take any income over the LTA as a lump sum, it will be taxed at an eye-watering 55%. If, instead, you take it as a regular income that could soften the blow slightly as it will be taxed at 25%. Although, that will be on top of your marginal rate so it’s still a minimum of 45% and could even cost you 65% if you’re a higher rate taxpayer. Ouch!

How could this impact me?

I can already hear you thinking “I don’t need to worry about that? A million pounds is a long way off!” Well, maybe it’s time to re-consider…

If you have £700,000 in your pension and it grew at around 5% a year, even if you completely stopped contributing, your pot would be over the million-pound mark in just over seven years – not that long at all. If you were also contributing £1,000 a month, you’ll have in excess of a million pounds in just six years – the lifetime allowance can creep up on you pretty quickly.

How can I prevent myself from being taxed at 55%

It’s important not to be complacent. If you don’t want the LTA to affect you, you have to plan ahead. Ultimately, depending on your objectives, there may come a point when it’s sensible to stop contributing to your pension and make use of some of the other tax wrappers available to you.

I must stress that stopping contributing to your pension certainly does not mean halting investing and saving entirely, which is another mistake people commonly make. It just means shifting your strategy slightly. Other suitable strategies could include taking your tax-free cash earlier than planned to ensure the growth on this doesn’t take you closer to the lifetime allowance, and you could consider how to use anything over the LTA for generational planning.

Generally, the lifetime allowance can become extremely complicated, particularly once you start taking income or if you have multiple schemes of different types. If you have pensions assets nearing £700,000 in value, you really should be working with a financial adviser.

So, if you have a decent pension pot and don’t want to end up being taxed as much as 65% take some advice and plan ahead!

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