What is the Lifetime Allowance for pensions?

The pension Lifetime Allowance, is a an overall limit on the amount that can be saved into pension schemes for a UK individual. The lifetime allowance, since April 2020, is £1,073,100 and it is likely to increase in line with inflation at the end of the current tax year.

The Lifetime Allowance has been introduced by the UK government as a limit on the total amount that can be saved in pension schemes over your life. If this Lifetime Allowance is exceeded, then a tax charge will be incurred, at the point which the excess savings are accessed.

The tax charge is either 55%, or 25% depending on the way you access the savings in excess of the Lifetime Allowance. Should the you access the excess savings by way of drawing an income, then the tax charge is 25%. If the amount is accessed as a lump sum, then the tax charge is 55%.

So, it seems like a simple decision! Surely you should take the funds as an income as the tax charge is much lower. In reality, the decision is not this easy to make, as when pension income is drawn, income tax will also be charged. Hence if you are a basic rate tax payer, your total tax charge would be the 20% basic rate of income tax, and 25% of the lifetime allowance tax charge, totalling 45%.

Hence, if you are a higher rate taxpayer, and the excess pension savings are drawn as an income, then the total tax charge could be 65%. If this does not make sense, please do let us know by emailing the support@wealthsimple.com team.