It’s fair to say that the Pension Lifetime Allowance, or LTA for short, is unpopular with pension savers. It’s complex and it deters us from funding our pension plans. Some of us go so far as to opt out of auto-enrolment in order to avoid the risk of reaching the LTA.
The LTA in a nutshell
If you’re saving into your pension, you’ve no doubt at least heard of the LTA, even if you don’t know the details. Essentially, it’s a limit to how much pension you can build up over your lifetime while enjoying tax benefits. It’s not a limit on how much you put in, but rather on the accrued value over time. Checks against the LTA are made at various points, including:
- Drawing a defined benefit pension.
- Taking income from a defined contribution pension.
- Taking a lump sum from a defined contribution pension.
- Reaching age 75.
- Dying before age 75.
If any of these (and some other) checks result in exceeding the LTA, the excess is subject to a charge. For lump sum withdrawals the charge is 55%. Where funds remain in the pension plan, the charge is 25%, but subsequent withdrawals are still subject to income tax.
The current LTA is £1,073,100, frozen until April 2025. It has varied considerably since it was introduced in 2006. Some people have obtained protections that keep their LTA at a higher historic level, subject to restrictions.
For a more thorough introduction, take a look at the MoneyHelper website.
The LTA and auto-enrolment
Are you an employee and part of an employer-funded defined contribution scheme? If so, and if you’ve already built up a sizeable pension pot, you may worry that you’ll reach the LTA. Should you opt out of further pension contributions? If this means completely losing your employer’s matching contributions, then the answer is a resounding ‘no’; matching contributions more than make up for any possible LTA charge.
The only time when opting out might make long-term sense is if your employer is willing to pay you the cash equivalent of the matching contributions; and then only if you’re at serious risk of exceeding your LTA. Even then, higher and additional rate taxpayers have less or no benefit from opting out, since this would lose immediate tax relief.
Despite the eye-watering charges for exceeding the LTA, the matching of contributions by employers makes opting out a fool’s game. It’s almost always best to maximise pension contributions that qualify for employer matching.
Self-employment and the LTA
Unlike employees, the self-employed don’t benefit from matching contributions. In this case, the decision whether or not to make further pension contributions needs to be more nuanced. If you’re a basic rate taxpayer at high risk of exceeding your LTA, then reducing or stopping pension contributions may be best. The higher your marginal tax rate, the more immediate tax relief you get when you fund your pension. Most people have less taxable income in retirement than before. This increases the long-term benefit for higher or additional rate taxpayers to fund their pensions, even when there’s a risk of exceeding the LTA.
The bigger picture
Lifetime allowance considerations form only part of the planning of pension contributions. Maximising your pension pot and minimising taxation are means to an end, not ends in themselves; the real ends are the availability of fund for consumption, and (for many) the preservation of assets for a legacy. Anyone who’s seriously worried about exceeding their LTA is unlikely to be over-spending; they’re more likely to be under-spending. Scrimping and saving while working in order to fund a lavish retirement is misguided, as you don’t know how long you’ll live.
It’s better to strive for consumption smoothing over your lifetime, consistent with your attitudes and goals. The EvolveMyRetirement® retirement planning calculator takes these into account, as well as taxation, uncertainty, and numerous other factors. Use it to optimise your planning strategy.