As if the NHS isn’t in enough trouble, it turns out some doctors are quitting general practice in their fifties partly because of the penal Lifetime Allowance Charge.
The Damaging Side-Effects Of The Lifetime Allowance Charge Are Hurting Loyal Workers And Diligent Investors
Isn’t It Now Time To Abolish Lifetime Allowance Charge?
Baroness Ros Altmann, who recently cashed in her final salary pensions, has written an article in The Telegraph in which she claims our draconian Lifetime Allowance rules are driving our best workers out of the labour market. It’s one of the unintended consequences of the continual cuts to pension allowances.
The Lifetime Allowance basically sees the Treasury taking your projected annual pension at the time you begin receiving it and multiplying it by 20. If the resultant sum is over the Lifetime Allowance, the Lifetime Allowance Charge could see you suffer an effective tax charge as high as 55 per cent on the excess.
At its peak, the Lifetime Allowance was £1.8 million, meaning you could enjoy a pension of £90,000 a year without incurring additional tax. But now the Lifetime Allowance has been cut to £1 million (tax year 2017/2018), more people with employer pensions are facing the Lifetime Allowance Charge and the prospect of a lot less money in retirement.
SIPP and SSAS savers are affected too. If your investments do well, you could end up being clobbered for a lot more tax in retirement.
As Baroness Altmann points out, some people are retiring early merely to avoid paying the Lifetime Allowance Charge, including some valuable workers in the NHS that we might prefer to see carrying on into their 70s.
If you are on course for a £50,000-a-year pension by the time you’re 60, you will know in advance that you will come in over the limit. In these circumstances, it makes sense to retire before you reach that point, which you can do at any age from 55, and take a reduced pension (the earlier you retire, the lower the pension).
This lets you avoid hitting the Lifetime Allowance, because the new rules don’t take into account that this lower pension would be paid for more years. They ignore the fact that you would probably receive the same amount – or even more – over your lifetime. By taking the lower pension, you can avoid the draconian pension tax, and still get the same expected pension payments in the end. This encourages GPs and senior workers to retire much younger than they otherwise might.
Read the article on the Lifetime Allowance Charge.
How Much Is The Lifetime Allowance?
The Lifetime Allowance for most people is £1 million in the tax year 2017-18.
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 government intends to index the standard Lifetime Allowance annually in line with the Consumer Prices Index.
How Is Lifetime Allowance Charge Calculated?
Every time a payout from your pension scheme starts, its value is compared against your remaining Lifetime Allowance to see if there is additional tax to pay.
You can work out whether you are likely to be affected by adding up the expected value of your payouts. You work out the value of pensions differently depending on the type of scheme you are in:
- For defined contribution pension schemes, including all personal pensions, the value of your benefits will be the value of your pension pot used to fund your retirement income and any lump sum.
- For defined benefit pension schemes, you calculate the total value by multiplying your expected annual pension by 20. In addition, you need to add to this the amount of any tax free cash lump sum if it is additional to the pension. In many schemes, you would only get a lump sum by giving up some pension, in which case the value of the full pension captures the full value of your payouts. So you are likely to be affected by the Lifetime Allowance Charge in 2017-18 if you are on track for a final salary pension (with no separate lump sum) of more than £50,000 a year, or a salary-related pension over £37,500 plus the maximum tax free cash lump sum.
- Certain tax free lump sum benefits paid out to your survivors if you die before age 75 also use up Lifetime Allowance.
- Whenever you start taking money from your pension, a statement from your scheme should tell you how much of your Lifetime Allowance you are using up.
- Whether or not you take money from your pension, a check will be made once you reach the age of 75 against any unused funds or undrawn entitlements.
How The Lifetime Allowance Charge Works
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. It’s known as the Lifetime Allowance Charge.
The way the Lifetime Allowance Charge is applied depends on whether you receive the money from your pension as a lump sum or as part of regular retirement income.
Lifetime Allowance Charge On Lump Sums
Any amount over your Lifetime Allowance that you take as a lump sum is taxed at 55 per cent. Your pension scheme administrator should deduct the tax and pay it over to HMRC, paying the balance to you.
Lifetime Allowance Charge On 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 per cent.
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 per cent tax to HMRC out of your pension pot, leaving you with the remaining 75 per cent to use towards your retirement income.
Here’s an example. Suppose you pay tax at the higher rate and had expected to get £1,000 a year as income. The 25 per cent Lifetime Allowance Charge will reduce this to £750 a year.
After Income Tax at 40 per cent, you would be left with £450 a year.
This means the Lifetime Allowance Charge and Income Tax combined have reduced your income by 55 per cent – the same as the Lifetime Allowance Charge had you drawn the benefits as a lump sum instead of income.
For defined benefit pension schemes, your pension scheme might 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.
It may be possible to apply for some protection against the Lifetime Allowance Charge, but the rules are pretty complex. You should check out the Government’s website to find more details about Lifetime Allowance and the Lifetime Allowance Charge.
Please Share This
If you’ve found this page interesting, please send a link to it to your friends using the buttons below. You’ll be helping us out, and your friends might appreciate it too, so please do it now. Thanks.
If you enjoyed this article, get email updates (it's free)
As SIPPclub neither advises on, nor arranges, nor recommends specific investments or strategies, we're unable to say whether a SIPP or SSAS or any investment within it is right for you. Ultimately, it’s your money and your decision, and you should only proceed once you're satisfied you've undertaken sufficient due diligence. If you need advice, you should speak to your trusted adviser, or you could find a local adviser from Unbiased.co.uk. Alternatively, we'd be pleased to introduce to a suitably qualified independent financial adviser.
Please read our full Terms which includes criteria for SIPPclub membership.