Will your UK pensions fall into the lifetime allowance tax trap?

If you have several pensions in the UK, have been saving for many years or have a generous company pension, you could be at a higher risk of 25% or 55% lifetime allowance tax charges after recent measures.

One key outcome of the 2021 UK budget was that the lifetime allowance for pensions (LTA) was frozen at its existing level for at least the next five years.

This measure alone is estimated to net the Treasury approximately ₤ 990 million by 2026, pushing an extra 10,000 people over the threshold.

With LTA tax charges of up to 55%, make sure you are not caught unprepared.

What is the lifetime allowance?

Since 2006, the UK government has capped how much money you can hold in combined pension benefits without paying additional tax. Originally ₤ 1.5 million, the LTA peaked in 2011 at ₤ 1.8 million before progressively dropping to ₤ 1 million in 2016. Tracking inflation since then, the March 2021 Budget cancelled this year’s scheduled increase, freezing the LTA at its current level of ₤ 1,073,100 until at least 2026.

Who is impacted by the lifetime allowance?

While the current lifetime allowance of ₤1,073,100 sounds high, it does not just catch the super-rich.

All UK pension benefits outside the State Pension are taken into consideration, including everything built up over a working lifetime. After many years of pension contributions, compounding interest, investment growth and tax relief, the limit may be closer than you think.

For ‘final salary’ (defined benefit) pension schemes, the typical measure of value is 20x the annual income due. In general, this will mean that people with pensions worth ₤53,655+ a year will be impacted today.

What are the lifetime allowance charges?

As soon as the total pension funds exceed the allowance limit, an additional tax is payable when you access your money, technically called a “benefit crystallisation event”.

How much you pay out depends on the way funds are taken out – the rates are:

55% for lump sums;

25% for income or transfers to an overseas pension.

At best, the cost of being in excess of the LTA can be a quarter of your money, at worst over half.

Being a non-UK resident does not provide any protection. Typically, under the double tax agreement, residents of countries like Portugal, Spain and France are not liable for UK taxes on British pensions (except government service pensions).

For anyone who exceeds the allowance, these rules do not apply: the LTA tax is first applied in the UK and can’t be claimed back.

How do you check your LTA position?

Calculating how much of your allowance you have used is not always simple, particularly for final salary pensions, so you ought to check your position with your provider or pension adviser. HM Revenue & Customs (HMRC) will first test your allowance status when you start withdrawing your pension, then each time you access money and when you turn 75. All lump sums paid to your beneficiaries will also be subject to the LTA test and subsequent tax charges if you die before the age of 75.

How can you safeguard your pensions from the lifetime allowance?

You could obtain a higher limit by applying for LTA ‘protection’ from HMRC, but this usually has stringent conditions attached, so take advice.

Expats have the option of transferring UK pension funds to a Qualifying Recognised Overseas Pension Scheme (QROPS).

You will not be taxed on the transfer if you transfer one or more UK pensions to a QROPS and your total benefits are below ₤ 1.073 million. However, make sure the QROPS is within the European Economic Area (EEA), otherwise you would still lose 25% through the ‘overseas transfer charge’.

When in a QROPS, funds are out of reach of LTA charges, no matter how much you have or how you access it. A suitable QROPS can also offer tax-efficiency, currency flexibility and estate planning benefits.

An alternative option is to take your UK pension as cash and reinvest it in a tax-efficient, compliant setup in your country of residence. Again, this can unlock various other benefits not usually offered with UK pensions.

Evaluating your pension options.

Prior to making major pension arrangements, it is important to take regulated, customised advice to avoid pension fraud and to find the most appropriate strategy for you.

What if you are currently over the limit?

Although you would trigger an immediate 25% LTA charge if you transferred to a QROPS, the funds become immune to further charges.

If you instead transferred to a UK scheme, like a Self-Invested Personal Pension (SIPP), you would not trigger immediate taxation, but the funds would remain liable, with future charges increasing as funds increased.

The 25% or 55% LTA charges would then become payable any time you take benefits, and also apply to any beneficiaries inheriting the pension.

If you are over or close to the LTA threshold, think about acting sooner rather than later. Your pension funds should continue to grow while the lifetime allowance stays frozen, so you could possibly avoid unneeded taxation by taking steps now.

Even if your pension benefits are within the allowance or you are not yet ready to access them, it is a good idea to assess your situation.

Lawsons Equity can help you explore your options and take advantage of tax-efficient opportunities to secure a comfortable retirement.

To schedule a no obligation initial consultation with one of our financial advisors, click here.

Information is based on our current understanding of taxation legislation and regulations. Any levels and bases of, and reliefs from, taxation are subject to change.

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