Pension lifetime allowance: What happens if my pension exceeds the Lifetime Allowance?
Under the current rules in the UK, most people will be enrolled into a company pension scheme where they will be able to save part of their salary on a monthly basis. If you decide to choose your own pension plan, however, then you will need to scour the market for the most suitable plan. But did you know your pension cannot exceed a certain sun over your lifetime?
What is the Lifetime allowance?
Unless you have protection, the standard lifetime allowance currently stands at £1,073,100.Each year the rate rises in line with CPI inflation.
The Pension Advisory Service explains: “While most people aren’t affected by the Lifetime Allowance, you should take action if the value of your pension benefits is approaching, or above, the lifetime allowance.
“As pensions are normally a long term commitment, what might appear modest today could exceed the lifetime allowance by the time you want to take your benefits.
“It may be necessary to take your pension early or stop contributing to the scheme/plan, even though you have not retired, to avoid your benefits exceeding the Lifetime Allowance.”
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What happens if my pension exceeds the Lifetime Allowance?
The Lifetime Allowance is measured every time you take benefits from a pension. When doing this, you use up a percentage of your Lifetime Allowance.
This is referred to as a Benefit Crystallisation Event (BCE).
For example, a pension fund worth £107,310 will use up 10 percent of the Lifetime Allowance if you took benefits from it in the tax year 2020/21.
Every time your pension is measured against the Lifetime Allowance, you should receive a certificate showing the percentage you have used up.
Unless you hold Lifetime Allowance protection, exceeding the limit will result in tax charges.
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Most people will never exceed the Lifetime Allowance, but if you do you will not receive tax relief on any contributions you paid that exceed the limit.
In addition to this, you will be faced with an annual allowance charge.
The annual charge will be combined with the rest of your taxable income for the year when determining your tax liability.
If the annual allowance charge exceeds £2,000, you can ask your pension scheme provider to pay the charge from your benefits.
This does, however, mean that your pension scheme benefits would be reduced.
Any amount over your lifetime allowance that you take as retirement income brings with it a lifetime allowance charge of 25 percent.
This is on top of any tax payable on the income in the usual way through income tax.
In the case of defined contribution pension schemes, your provider should pay 25 percent tax to HMRC out of your pension fund, leaving you with the remaining 75 percent to use towards retirement income.
For example, if someone who pays a higher tax rate expected to receive e£1,000 as a year as income from their pension, the 25 percent tax rate would reduce this sum to £750.
After income tax, which is paid at 40 percent for said person, they would be left with £450 a year.
In total, the lifetime allowance charge and Income Tax have reduced the £1,000 income by 55 percent – the same as the lifetime allowance charge if the benefits had been retrieved as a lump sum as opposed to income.
There are several schemes that allow you to protect your lifetime allowance. You can check if you already have protection, but to do so you will need an account for HMRC’s online serviced.
You can apply for Individual Protection 2016 if your pension fund exceeded £1million on 5 April 2016.
This scheme was introduced to protect lifetime allowances and allows people to continue building up their pension.
Fixed protection 2016 locks your pension in at £1.25million, but you will no longer be able to contribute to your pension.
This scheme usually works for people who no longer want or need to save into a pension.
If you do put money into a pension fund after having fixed protection, you will lose it and will be forced to pay a tax charge on the excess.
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