The lifetime allowance is currently £1,073,100 for the 2022/23 tax year. This doesn’t mean you’re unable to save above this amount, there’s no upper or lower cap for how much money you can have in your pensions. However, any amount over the lifetime allowance will be taxed at a higher rate. This is in addition to any income tax you’ll need to pay on withdrawals.
The introduction of Auto-Enrolment has increased the likelihood that those earning the average UK salary will hit their lifetime allowance as they get closer to the typical retirement age. Therefore, it’s important for everyone to be aware of the implications of exceeding the lifetime allowance.
Lifetime allowance table
In April 2022 the lifetime allowance remained unchanged and is currently £1,073,100. This means you can withdraw up to £1,073,100 during your retirement, before you’ll need to pay the lifetime allowance charge.
The lifetime allowance applies to all of the personal or workplace pensions you have, including defined benefit pensions and defined contribution pensions. It does not, however, include your State Pension allowance. The tax you’ll pay if you exceed the lifetime allowance is on top of income tax.
How to calculate lifetime allowance
When you start drawing down your pension, the value of your withdrawals will be deducted from your lifetime allowance and should be clearly marked on your statements. While the lifetime allowance won’t affect everyone, it’s worth calculating the expected value of your withdrawals in retirement to avoid any potential charges. It’s especially valuable to do so if you’ve built up a sizeable pension pot.
Defined contribution pensions: most people will have a defined contribution pension which will be valued based on how much money they’ve paid in and how their investments have performed. It’s this value that will be checked against your lifetime allowance each time you take money out of your pension.
Defined benefit pensions: if you have a defined benefit pension, or final salary pension, the value will be based on your salary and the number of years you’ve worked for your employer. If you have a defined benefit pension you can calculate the total value by multiplying your expected annual pension by 20. If you’re eligible to receive a tax-free lump sum it would also need to be included in this calculation.
Will I reach my lifetime allowance?
The below table shows data from the Office for National Statistics (ONS) of the average annual income for those in the average and top 10% income brackets.
|Income bracket||Average annual income|
|Age 18-21||Age 22-29||Age 30-39||Age 40-49||Age 50-59||Age 60-69|
Source: PensionBee, May 2022, using data ONS Earnings and hours worked, age group: ASHE Table 6
The below table shows Pensionbee’s latest modelling on the likelihood of reaching your annual allowance depending on your income.
|Age began work pension contributions||Income bracket||Age first expected to exceed current lifetime allowance||Expected pot size by age 60|
Source: PensionBee, May 2022, using data ONS Earnings and hours worked, age group: ASHE Table 6. Assumes any due tax relief, and a 15% total contribution (8% auto-enrolment and 7% personal or employer contribution), and that workers aged below 22 have opted into their workplace pensions. It also assumes 7% annual growth.
Lifetime allowance charge
The amount of extra tax you pay if you exceed the lifetime allowance will vary depending on how the money is paid to you. If you take your pension as a lump sum, 55% tax will be charged and 25% on top of the usual income tax if you take it another way, such as drawdown or via an annuity.
Lifetime allowance charge examples
Here are some examples to demonstrate how the lifetime allowance charge works.
Example 1: if you have a pension with a value of £1,073,100 you won’t have to pay any additional tax as you are within the lifetime allowance of £1,073,100.
Example 2: if you have a pension with a value of £1,078,100 you can draw the first £1,073,100 before tax is charged. Tax will then be applied to the £5,000 excess. If you take it as a lump sum you’ll pay £2,750 tax (55%), but if you take it through drawdown or an annuity you’ll pay £1,250 (25%), plus income tax.
Example 3: if you have a pension with a value of £2,000,000 you can draw the first £1,073,100 before tax is charged. Tax will then be applied to the £926,900 excess. Take it as a lump sum and pay £509,795 tax (55%) or via drawdown or an annuity and pay £231,725 (25%), plus income tax.
Lifetime allowance increases
The lifetime allowance is usually indexed annually in line with the Consumer Prices Index (CPI). However, this has been frozen at £1,073,100 for five years in the March 2020 Budget. This means the lifetime allowance can be expected to stay at £1,073,100 until 2025/26.
The lifetime allowance has a history of rising and falling, with a peak of £1,800,000 and a low of £1,000,000 in the last decade. Although the discrepancies from year to year can seem small, they can make a big difference to savers with larger pots and generate significant tax savings.
If you’ve built up a high value of benefits you may be able to apply for ‘protection’ against tax charges. There are four main options; primary protection, enhanced protection, fixed protection and individual protection.
If you think the value of your pensions is approaching the lifetime allowance you should consider taking action. PensionBee can help you calculate how much your pensions are worth, as once you’ve found any old workplace pensions we can help you consolidate these together with a pension provider name and ideally the policy number too. This will give you much greater clarity over what you have saved. Sign up to PensionBee today and combine your pensions into one simple plan that you can easily manage online.
As always with investments, your capital is at risk. The value of your investment can go down as well as up, and you may get back less than you invest. This information should not be regarded as financial advice.
Last edited: 28-11-2022