In this article I’m going to show you, in simple steps, how to calculate the pension lifetime allowance in relation to your pension planning.
But before I show you how to calculate the pension lifetime allowance you may not be fully aware of what the pension lifetime allowance actually is.
What is it and how to calculate the pension lifetime allowance
The pension lifetime allowance is essentially the total amount of money you are allowed to hold in pensions.
When looking at how to calculate the pension lifetime allowance you need to consider all types of pensions you have including personal pensions, pensions arranged via your employer and final salary pensions including public sector schemes like the NHS and Local Government pensions.
The only pension that is not included in how to calculate the pension lifetime allowance is the State Pension.
The current lifetime allowance for the 2017/18 tax year is £1 million. It was announced in the latest budget that the lifetime allowance will rise to £1.03 million from the start of the 2018/19 tax year.
If your total pension ‘pot’ is over the pension lifetime allowance then nothing happens immediately. But at the point you make a withdrawal from any of your pensions, whether it’s starting a final salary pension or withdrawing money using pension drawdown. A lifetime allowance test will be applied.
Only the pension you have used to provide you with a pension income will be tested at this point. The value of this pension will be proportioned against the lifetime allowance. So for example, if you transfer a £100,000 pension into drawdown, this will use 10% of your pension lifetime allowance and no further action will be taken as you still have 90% of your allowance available for future pensions.
However should you perhaps start to receive an income from a final salary pension as well as your pension drawdown and it’s value for lifetime allowance purposes is calculated to be £1 million, then you would have used 110% of your pension lifetime allowance and you will therefore face a lifetime allowance tax charge on top of the normal Income Tax charge you pay for withdrawing from a pension.
The rate of lifetime allowance charge you pay will depend on whether you take the money out of the pension as income (tax charge 25%) or a lump sum ( tax charge 55%).
How to calculate the pension lifetime allowance for your own pensions
- Add up the value of all your money purchase pensions – pensions that you have contributed to and there is a value based on the contributions made and investment returns.
- Look at the projected annual income due to be paid on any final salary pensions you have.
- Multiply this annual income figure by 20 and add it to any lump sums you are entitled to from the final salary scheme.
- Don’t use the cash equivalent transfer value in how to work out the pension lifetime allowance for your final salary pension as this does not count.
- Many people who have final salary pensions get caught out by the pension lifetime allowance because they can’t see the underlying value of the pension.
- Check for any pensions that you put into pension drawdown before 6th April 2006.
- If the pension drawdown is still paid out under ‘capped drawdown’ rules then you will need to work out the maximum annual income you are allowed to take, multiply this by 80% and then multiply the resulting figure by 25 to work out the total for lifetime allowance purposes.
- Check for any pensions that you sold for an annuity (income for life).
- Work out the latest annual income and multiply this figure by 25.
Adding together the totals from steps 1-4 will give you your total pension ‘pot’ in how to calculate the pension lifetime allowance.
Be aware that if you have started a final salary pension, purchased a pension annuity or moved a pension to drawdown since 2006 then you will already have used some or all of your pension lifetime allowance.
What to do when you know how to calculate the pension lifetime allowance
The immediate thought for many people when they have looked at how to calculate the pension lifetime allowance and realise they are already over or close to the limit is to stop paying into pensions.
Please don’t rush into this course of action. Yes it might be right for some people but it may not be the best move for others.
Consider this, if you are still working and your employer is making pension contributions on your behalf then you are effectively receiving free money. Even if this free money takes you over the pension lifetime allowance it’s better to receive 45% (after lifetime allowance tax) of the free money rather than nothing at all.
There are certain protections that, if you qualify, can be put in place to increase your lifetime allowance. This is a complex area and the subject for another article another day! You can start to find out more on lifetime allowance protection here.
If you have significant sums in pensions and believe you have a lifetime allowance problem then this is where taking professional advice can really save you large tax penalties. Please give us a call to arrange an appointment at our expense where we will be happy to check your position and give you some options.
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