How to manage your pension lifetime allowance

The government’s decision to freeze the pension lifetime allowance until 2026 could see more people inadvertently breaching the allowance and facing a hefty tax charge when they come to draw pension income.

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Understanding how to manage your lifetime allowance and what to do if you are nearing the limit can be complicated. Exceeding the lifetime allowance isn’t always a bad thing, but it’s important to seek financial advice on what is right for you. In the meantime, this short guide to the lifetime allowance answers some of the most common questions people have.

What is the lifetime allowance?

The lifetime allowance is the amount of money you can build up in pensions without triggering a tax charge when you come to access your pension benefits. The lifetime allowance for 2022/23 is £1,073,100, and the government has announced that it will be frozen at this level until 2026¹.

The limit applies to all your UK pensions other than the state pension. It includes self-invested personal pensions (SIPPs), workplace and occupational pensions, and any other personal pensions you may have.

Your lifetime allowance might be greater than the standard amount if you have made use of the lifetime allowance ‘protections’ introduced over the years. A financial adviser can explain whether you might be eligible for any of these protections and, if so, whether they’re appropriate for your individual circumstances.

What happens if I exceed the lifetime allowance?

Your pension benefits will be tested against the lifetime allowance at several stages, including when you access your pension benefits, when you turn age 75, or if you die before age 75 with benefits that haven’t yet been tested. After age 75, there are generally no further checks.

If you access, or ‘crystallise’, pension benefits in excess of the lifetime allowance, the excess will be subject to a tax charge. The rate of this charge depends on how excess benefits are taken. If they are taken as a lump sum the rate is 55%. If they are taken as income the rate is 25% – this will be on top of any regular income tax you pay.

Your pension scheme administrator will usually deduct any lifetime allowance tax charge due on your behalf.

How do I know if I’ve breached the lifetime allowance?

Knowing whether you have breached or are nearing the lifetime allowance isn’t always easy. You might have several different pensions with separate providers, making it hard to work out the total value of your pensions.

If you are a member of a defined benefit, or final salary pension scheme, it can be particularly difficult to know exactly where you stand, although there are calculations available online that can be used for these types of pension schemes.

A financial adviser can help you work out the true value of your pension pots and clarify whether you have exceeded, or are close to exceeding, your lifetime allowance.

How could the lifetime allowance freeze affect me?

The lifetime allowance was frozen at £1,073,100 in April 2021 for five years. While the lifetime allowance might seem like a lot, freezing it rather than increasing it in line with inflation could see more people inadvertently breaching the threshold.

Wages more or less keep pace with inflation and so you could find you’re saving more into your pension each month, pushing you closer to the lifetime allowance. When you add on investment growth over the years, and the fact that many of us are working well into our 60s and therefore saving into pensions for longer, it’s easy to see why more people are expected to exceed an allowance that has been fixed for several years.

There are ways to manage your pensions if you are approaching the limit, such as considering other types of investments, stopping contributions, or taking your pension benefits sooner than anticipated. But it’s really important to ensure you are taking the right steps for your individual circumstances.

What should I do if I’m nearing the lifetime allowance?

If you think you’re nearing the lifetime allowance, it’s important to seek advice so that you can weigh up the pros and cons of different courses of action.

It may be that you’re better off continuing to save into a pension rather than fearing tax charges that don’t actually happen. Stopping pension contributions early could simply mean you end up with less money in retirement and don’t even come close to the lifetime allowance. Missing out on employer contributions, as well as valuable tax relief on personal pension contributions, could prove to be a costly mistake.

Bear in mind that pensions can also form a useful part of inheritance tax (IHT) planning. Your beneficiaries can usually inherit your pension fund without it being subject to IHT, or it counting towards their own lifetime allowance.

Which other types of investments could I use?

If you are close to the lifetime allowance and want to avoid breaching it, there are other investments to consider.

For example, you can save up to a maximum of £20,000 into ISAs each tax year and there is no limit on the amount you can tax-efficiently build up in ISAs over your lifetime. You can withdraw money from ISAs tax free, which makes them a tax-efficient source of retirement income.

There are other types of tax-efficient investments, but some of these are higher risk and so it’s essential to seek advice before investing.

Next steps

Understanding how the lifetime allowance affects you and how to manage it isn’t easy, and that’s where getting some smart advice can help. A financial adviser can clarify whether you are close to breaching the lifetime allowance, run through all your options, and explain how to manage potential tax liabilities. By getting advice that is tailored to your individual circumstances, you’ll feel more confident that you’re making the right decisions for you.