How to manage the Lifetime Allowance to make your retirement savings work harder…

Did you know that the Lifetime Allowance (LTA) tax charge on your pension could be costing you more than 55% of your hard-earned retirement savings?

The 55% tax charge for exceeding the LTA sounds intimidating enough, however, many people end up with an effective tax charge of more than this. Ironically, this is often the result of trying to beat the system.

What is the Lifetime Allowance?

The Lifetime Allowance (LTA) is the limit of the funds an individual can build within their combined pensions during their lifetime before incurring an LTA tax charge. Now, there are two important words used within that explanation that can easily get overlooked:

“Build”
“Combined”

Build – This is important to note as any growth that is made on top of your pension contributions is also included when assessing the LTA, along with any basic rate tax relief that is claimed at source for personal contributions.

Combined – All of your pension pots count towards the LTA. This means that if you are lucky enough to have an old Defined Benefit pension that you will need to factor this into any calculations also. This is typically based on 20x your annual pension at retirement plus any tax-free cash however there are many more complexities with pensions in payment pre/post 2006 and therefore it is important that you seek advice if you are affected by this.

The trap

If you are fortunate enough to have pension assets that are in excess of the LTA, you have two options when it comes to paying the charge:

Case study

Current LTA: £1,073,100
Current Fund Value: £1,173,100

Assuming that all three clients below are crystallised up to the standard LTA and have no form of protection, you can see the difference in the effective tax charge for taking their benefits in excess of the LTA as regular income:

As you can see, the only real winner in this scenario is the basic rate taxpayer. Government figures identify an 8.8% increase in pensioners who were additional rate taxpayers in 2019/20 compared to 2018/19. Whilst all of their income may not be generated from pension wrappers, the unfortunate truth is that they will still be eligible to be snared by the LTA.

Now, not everyone will be in the position to fund multiple wrappers, so the key takeaway is the importance of the balancing act. This is just as vital in the accumulation phase as it is in retirement: you’re less likely to get that nasty LTA tax charge surprise if you have been actively balancing your “taps” from an earlier age.

In practice, you can draw tax free income from your ISA; utilise your capital gains allowance within your GIA; benefit from tax deferred withdrawals from an investment bond; reduce your inheritance tax liability with AIM shares in place of pension funding; all whilst maximising the tax allowances afforded to you on an annual basis. A blend of these tactics, plus many more, allows you flexibility to control your tax position in retirement and turn on/off any taps as and when you need to.

Use these tactics effectively and you can easily draw well in excess of £125,000 per annum whilst remaining a basic rate taxpayer. Indeed, the additional rate taxpayer in the aforementioned case study could have saved £18,750 by using the above blend.

New car…or £18,750 tax bill?
Help the kids on the property ladder…or £18,750 tax bill?
Around the world cruise…or £18,750 tax bill?

It’s never too early to start planning this process and it will, of course, be different for everyone. People have their own goals and ambitions and often more than one, so why only have one retirement pot? Avoid the 58.75% and take that world cruise…