Why monitoring the value of your pensions is important

A lifetime allowance puts a limit on the value of pension benefits that you can receive without having to pay a tax charge. The lifetime allowance is £1 million for the tax year 2016/17.

Any amount above this is subject to a tax charge of 25% if paid as pension or 55% if paid as a lump sum.

It applies to the total of all the pensions you have, including the value of pensions promised through any defined benefit schemes you belong to, but excluding your State Pension.

From 6 April 2018, the standard lifetime allowance will be indexed annually in line with the Consumer Prices Index (CPI).

Charges if you exceed the lifetime allowance

If the cumulative value of the payouts from your pension pots, including the value of the payouts from any defined benefit schemes, exceeds the lifetime allowance, there will be tax on the excess – called the ‘lifetime allowance charge’.

The way the charge applies depends on whether you receive the money from your pension as a lump sum or as part of regular retirement income.

Lump sums

Any amount over your lifetime allowance that you take as a lump sum is taxed at 55%. Your pension scheme administrator should deduct the tax and pay it over to HM Revenue & Customs (HMRC), paying the balance to you.

Regular retirement income

Any amount over your lifetime allowance that you take as a regular retirement income – for instance, by buying an annuity – attracts a lifetime allowance charge of 25%. This is on top of any tax payable on the income in the usual way.

For defined contribution pension schemes, your pension scheme administrator should pay the 25% tax to HMRC out of your pension pot, leaving you with the remaining 75% to use towards your retirement income.

Lifetime allowance charge and Income Tax combined

For example, suppose someone who pays tax at the higher rate had expected to get £1,000 a year as income but the 25% lifetime allowance reduced this to £750 a year. After Income Tax at 40%, the person would be left with £450 a year. This means the lifetime allowance charge and Income Tax combined have reduced the income by 55% – the same as the lifetime allowance charge had the benefits been taken as a lump sum instead of income.

For defined benefit pension schemes, your pension scheme may decide to pay the tax on your behalf and recover it from you by reducing your pension.

If you wish to avoid the lifetime allowance charge, it’s important to monitor the value of your pensions, and especially the value of changes to any defined benefit pensions as these can be surprisingly large.

The ‘annual allowance’ is a limit on the amount that can be contributed to your pension each year, while still receiving tax relief. It’s based on your earnings for the year and is capped at £40,000, which still remains unchanged following the Autumn Statement 2016.