Lifetime Allowance – how to pay less tax

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Pension lifetime allowance explained 

You can save as much as you want in your pension – but if you exceed the Pension Lifetime Allowance, you will be hit with a hefty tax charge.

This article will:

  1. Explain how the pension lifetime allowance works
  2. Show you how to increase your pension lifetime allowances
  3. Provide you with simple ways to reduce the lifetime allowance tax charge
  4. Show you lifetime allowance strategies to pay less tax

Lifetime allowance consultation

If you’re concerned about the pension LTA, we offer a lifetime allowance consultation. We will use this meeting to discuss your current pension situation and how we can help you avoid unnecessary lifetime allowance charges.

Schedule a lifetime allowance consultation.

What is the lifetime allowance?

If the value of your pension exceeds the Lifetime Allowance, you will pay a tax charge, known as the Lifetime Allowance tax charge.

The standard Lifetime Allowance is currently £1,073,100 (2020-2021).

Since 2018/19, the lifetime allowance has increased each year with inflation (as measured by the Consumer Prices Index rate the previous September).

There are several scenarios that trigger a Lifetime Allowance test, and thus a possible tax charge, including taking money out of your pension, transferring your pension overseas, or turning 75 without having taken benefits from your pensions.

What is the lifetime allowance tax charge?

The amount you have in your pension above the LTA is subject to a tax charge.

What happens if you go over the pension lifetime allowance? You pay a tax charge.

The rate of tax you’ll pay will depend on how you withdraw your money from your pensions.

This tax charge is paid in one of the following ways:

  1. 25%, if taken as income (i.e. this is the case if you buy an annuity or take a regular income via drawdown), or,
  2. 55%, if taken as a lump sum  (i.e. this is the case if you take an uncrystallised fund lump sum)

The charge can be applied in either of the two ways or a combination of both depending on how you take the excess benefits above the lifetime allowance.

Remember, the LTA charge is in addition to income tax charges paid when you withdraw funds from your pension.

What counts towards your lifetime allowance?

The LTA applies to the value of all your pensions. This includes defined benefit (final salary) pensions and defined contribution pensions. However, the LTA does not include the State Pension.

The amount that counts towards your LTA will depend on the type of pension you have. The below table summarises a defined benefit lifetime allowance calculation and a defined contribution lifetime allowance calculation:

pension lifetime allowance, Lifetime Allowance – how to pay less tax, Frazer James Financial Advisers

For further information about how pension benefits are calculated.

Additionally, some death-in-service benefits – employee benefits that are paid out as a tax-free lump sum also count towards the LTA.

Is it worth exceeding the lifetime allowance?

Where possible, you want to avoid exceeding the lifetime allowance. Otherwise, you’re going to pay the lifetime allowance tax charge.

However, there are circumstances where it may make sense to exceed the lifetime allowance. These include:

  1. Contributing to your workplace pension to receive an employer-matched contribution. Although you will pay a 25% lifetime allowance tax charge, you are effectively getting a 100% return on your contribution (assuming your employer matches the contribution 1:1).
  2. Contributing to a pension to avoid a future inheritance tax bill. Pensions are outside of your estate, so you won’t pay inheritance tax on them. It may be better to pay the 25% lifetime allowance tax charge than the 40% inheritance tax charge.
  3. Contributing to a defined benefit pension. These are very valuable pensions and the income you receive from them is normally worth far more than any tax charge that will apply.

When does the lifetime allowance test apply?

There are several scenarios that trigger a test against the LTA. These scenarios are known as ‘benefit crystallisation events’ (BCEs). These are defined by HMRC and there are 13 of them in total.

The most common BCEs include:

  1. Accessing your pension – by taking a lump sum or income
  2. Turning age 75 – and not having drawn pension benefits and/or having some pension funds in drawdown at age 75
  3. Transferring a pension to a qualifying recognised overseas pension scheme (QROPS)
  4. Receiving a lump sum death benefit before age 75

How can I reduce the lifetime allowance charge?

Step 1 – Understand the value of your pensions

The first step in planning for the LTA is to calculate whether you are at risk of exceeding the threshold.

The way you do this is by:

  1. Calculating the total value of all your pensions now; and
  2. Projecting what the total value could reach when you retire (taking into account future contributions and reasonable investment growth rates)

Remember that for lifetime allowance purposes, the value of your pensions will be calculated differently depending on the type of pension.

If you are still an active member of a defined benefit pension scheme, it will be difficult to predict what your final benefits will be, as they will be linked to your pensionable salary, accrual rate and length of service.

In order to avoid a hefty tax charge on your savings, you’ll need to monitor your pensions closely to ensure you don’t exceed the LTA.

If you are unsure about how to calculate the total value of your pension accounts, feel free to give me a call and I’ll help you do this.

Step 2 – How to protect your lifetime allowance

If you are likely to exceed the lifetime allowance, you should consider applying for ‘lifetime allowance protection’.

There are two types of protection you can apply for which have replaced previous versions:

2a. Individual Protection 2016

If your pension(s) were worth more than £1m on 5th April 2016, you can apply for Individual Protection 2016.

This protects your lifetime allowance at the value of your pensions on 5th April 2016 or £1.25m, whichever is the lower.

You and your employer can continue paying into your pension, however, a lifetime allowance charge will apply on any value in excess of your protected lifetime allowance amount.

The benefit of doing this is that it increases your lifetime allowance from £1,073,100 currently to up to £1,250,000. This can save you up to £97,295 in lifetime allowance tax charges.

2b.  Fixed Protection 2016

This protection fixes your lifetime allowance at £1.25m, regardless of the value of your pensions.

The catch is that you can only apply for fixed protection 2016 if you (or your employer) have not added to your pension since 6th April 2016.

You can’t apply for this protection if you have enhanced protection, primary protection, fixed protection or fixed protection 2014.

2c.  How do I apply for lifetime allowance protection?

Click here to apply for individual protection or fixed protection.

Step 3 – Pension lifetime allowance strategies 

Of course, this depends on individual circumstances and can get rather complicated.

Here are some simple ideas to think about.

3.  Use your ISA

You could reallocate contributions you’re making into a defined contribution pension that is nearing the LTA into an Individual Savings Account (ISA). ISAs enable you to invest your money tax-free, and any money in an ISA will not count towards your LTA. You can currently contribute £20,000 per year into an ISA.

This strategy is not suited to those in defined benefit pension schemes as these individuals are likely to be better off continuing to accrue benefits within their scheme, even after the lifetime allowance charge.

3b.  Use your spouse’s pension

If you’re approaching the lifetime allowance, it might make sense to redirect contributions into your spouse’s pension (this is just one of the four main tax benefits of marriage)

This will need to be in their name of course – and that comes with risks of its own (what happens if you get divorced?).

You each have a lifetime allowance, so by using both allowances you can potentially increase the amount in your pensions by 100% before paying any lifetime allowance charge.

3c.  Retire early

If you have a defined benefit pension, you could consider retiring early.

Most defined benefit pension providers offer a lower level of income if you begin taking benefits before reaching your normal retirement age. As such, retiring early and taking a lower annual income could potentially help you reduce the value of your pension below the Lifetime Allowance.

You could also ask the pension scheme if it offers the option to reduce the way you are accruing future benefits. If it does, you could continue to build up your pension but on a reduced basis.

3d.  Phased retirement

You could consider delaying retirement or phasing your retirement benefits (if you’re unsure if you can afford to retire early, check out this article).

Assuming that the LTA continues to increase in line with CPI in the future, this strategy could enable you to take advantage of a higher threshold, and, therefore, avoid or reduce tax charges.

3e.  Withdraw tax-free cash

A common strategy is to withdraw tax-free cash from the pension. This leaves fewer funds in the pension to grow, reducing the potential second LTA charge at age 75.

You should, however, note that any funds withdrawn from a pension will form part of your estate for inheritance tax purposes – whereas funds held in a pension are outside of your estate for inheritance tax.

Next steps

Even if you’re not already breaching the LTA now, taking prudent steps in advance is a good idea.

It may be necessary to stop contributing to your pension and instead, contribute to other investment vehicles, or perhaps even take your pension early to avoid being taxed excessively.

The tax rules regarding the Lifetime Allowance are complicated, with the cost of getting it wrong nothing short of expensive.

If you want to know more about how we can help, you’re welcome to book in for a ‘Quick Financial Call’.

All the best,

pension lifetime allowance, Frazer James Financial Advisers

James Mackay, Independent Financial Adviser in Bristol

P.s – make sure to download your guide to the pension lifetime allowance.

P.p.s – if you’re looking for even more ways to save tax, check out my article on 10 ways to reduce your tax bill.




Financial Advisor Bristol and Pension Advisor Clifton

Frazer James Financial Advisers is an Independent Financial Advisor based in Clifton, Bristol.

About us: Frazer James Financial Advisers is a financial advisor, based in Clifton, Bristol. As an independent financial adviser, we’re able to provide independent and unbiased financial advice. We provide independent financial advice, pension advice, investment advice, inheritance tax planning and insurance advice.

If you would like to speak to a Financial Advisor, we offer an Initial Financial Consultation without cost or commitment. Meetings are held either at our offices, by video or by telephone. Our telephone number is 0117 990 2602.

Frazer James Financial Advisers is located at Square Works, 17 – 18 Berkeley Square, Bristol, BS8 1HB.

This article provides information about investing, but not personal advice. If you’re not sure which investments are right for you, please request advice.

Remember that investments can go up and down in value, you may get back less than you put in.

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