The pension lifetime allowance: Is it time to tend to your retirement?

You can save as much as you want to towards your pension, but if it exceeds a total amount – in other words, the lifetime allowance – you could face a hefty tax bill on anything you withdraw above this figure.


Now that the Chancellor has frozen the lifetime allowance of £1,073,100 until 2026, is it time to consider a broader range of savings options for your retirement?

Overview:

  • If you accumulate more than £1,073,100 in pension savings (the lifetime allowance), you risk being taxed on anything above this figure that you withdraw when you retire.
  • Defined-contribution and defined-benefit pensions are equally applicable. Either way, the sums can be complicated – so for reassurance, always seek professional financial advice.
  • A growing number of individuals are likely to be close to their lifetime allowance in the future, due to the freeze – if you’re affected, consider additional options to complement saving for retirement, such as ISAs and property.

Chancellor Rishi Sunak announced in his March Budget that the pension lifetime allowance would be frozen at its current level of £1,073,100, until April 2026.

This limit on how much you can pay into your pension – before it becomes liable for taxation when you take it out – means that an increasing number of people could be met by a substantial tax bill when they retire. The current rules set out that tax is payable at 55% on everything over the £1,073,100 cap if you take the money as a lump sum, or 25% if you take the money in another way – for example, an annuity or drawdown.

Here, Tony Clark, Senior Propositions Manager at St. James’s Place Wealth Management, answers some frequently asked questions about how this might affect you and your pension.

Isn’t the lifetime allowance freeze only a problem for the richest people who’ll be lucky enough to reach the limit?

The wealthiest investors will indeed feel the greatest impact from the lifetime allowance freeze, but bear in mind that there will also be somewhat of a ‘drag’ effect too – potentially causing issues for many ‘middle-earners’, who may not necessarily see it as an issue as things stand. The reason for this is that, if and when the lifetime allowance starts to increase again in five years’ time, its starting point will be lower – meaning that more people will be expected to reach the limit in the future. So while many investors might not see it at the moment, or even in the next few years, it may nevertheless become problematic for them in due course.

Furthermore, because the concept of retirement is ever-changing, a lot of people will continue working well into their mid-60s and beyond, meaning they could carry on paying into a pension for a longer time – giving them a longer period for possible growth and an increased likelihood of reaching that lifetime allowance.

Does the lifetime allowance only affect people with a defined-contribution pension?

No, it doesn’t, as the allowance covers both defined-contribution and defined-benefit pensions. A lot of commentators are concentrating on the defined-contribution side because the maths is more straightforward. As for defined-benefit pensions, understanding the potential tax situation and how it’s calculated is much more complex.

Furthermore, many people, usually in their 40s and early 50s, might have a blend of both – plus the rules apply across the two, meaning you can end up with a mathematical conundrum. A lot of people in that situation will no doubt be wondering: “Where do I even start with trying to figure it out?” A financial adviser is your best ally in this scenario, and can best explain how it will develop for you.

Should we be feeling worried about the prospect of having to pay extra tax when we retire?

When the lifetime allowance freeze was announced, there was a lot of despondency surrounding it. For instance, some people were saying that it would make pensions less appealing; however, I disagree. People should not feel deterred by pensions – after all, they’re the most tax-efficient way of saving for your retirement by far, particularly considering the tax relief available on your contributions, not to mention the freedom of choice you have nowadays in how you access your pension when the time comes.

And so, rather than thinking of the freeze as a block or problem, adopt the viewpoint that approaching that limit could act as a trigger to weigh up your options. At this stage, it might be helpful to seek financial advice, understand the details of your own circumstances, and ask questions such as: “Do I need to worry about this? If so, do I need to adjust my course?”

What other measures can people consider if they’re likely to reach their lifetime allowance limit?

Being aware of the situation, knowing what’s there and realising that you don’t have to take matters into your own hands are all important factors.

Keep your end goals at the forefront of your mind – contemplate how you envisage your retirement, and then you can reflect on how you might structure your income in retirement and how to save for it today. Nowadays, a lot of people require a range of assets to draw from – their pension being just one of these. But tax-efficient ISAs can also be considered, as can property, other investments, state benefits and the fact that you might still be earning. Having all of these different elements on your radar means that, when you reach retirement, you can work out which to pull on in order to generate your income.

A pension will make up the majority of some people’s retirement wealth, whereas others will discover that retirement is less linear – especially for people who are only in their 40s or 50s now – meaning they may want to take a broader approach. Either way, it would be prudent to see the pensions lifetime allowance as a reason to have regular pension reviews with your expert adviser, as opposed to not having a pension full stop.

If it’s important to you to tend to your retirement and make the most of your pension, why not contact your Wellesley adviser on 01444 244551 to discover your most suitable saving options?

The value of an investment with St. James’s Place will be directly linked to the performance of the funds selected and may fall as well as rise. You may get back less than the amount invested.

The levels and bases of taxation, and reliefs from taxation, can change at any time and are generally dependent on individual circumstances.

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