What is the Lifetime Allowance, how does it work, and why might it affect me?

Pensions are one of the most tax-efficient ways to save. From generous tax relief on contributions to the tax-efficient wrapper within which your pot grows, they have long been a popular way to build up a retirement fund.

The latest figures show that pension tax relief cost the government almost £40 billion in the current tax year. It’s a costly expense for the chancellor – especially in the wake of unprecedented coronavirus borrowing – so it’s perhaps no surprise that successive governments have looked for ways to limit the tax benefits an individual can enjoy.
One such way is the Lifetime Allowance. The chancellor recently confirmed he was freezing this valuable pension allowance until 2026 – so read on to find out more about what the Lifetime Allowance is, how it works, and why it might affect you.

What is the Lifetime Allowance?

The Lifetime Allowance represents the total amount you can build up in pension benefits over your lifetime while still enjoying the tax advantages.
In the 2021/22 tax year it stands at £1,073,100 and will remain at this level until 2026.
If the value of your pension savings exceeds this limit – perhaps because of your contributions or thanks to investment growth – you will generally pay a tax charge on the amount over your allowance when you:

• Take income or a lump sum from your fund
• Reach age 75 with unused pension benefits
• Die.
• There are other events but those above are the most common.
Remember that the allowance applies to the value of all your pension arrangements. This could include:
• Defined contribution (money purchase) pensions such as workplace or personal pensions
• Defined benefit (final salary) pensions
• Any pension that has paid you a lump sum or income.

These tax charges can be significant – up to 55% in some cases – so it’s important that you know about the Lifetime Allowance and how it can affect you.

How does the Lifetime Allowance work?

At every point where you access your pension, or at age 75 whether you have withdrawn pension benefits or not, your pension will be “tested” against the Lifetime Allowance. This is called a “benefit crystallisation event”.
Note that you don’t immediately pay a tax charge if the value of your pension exceeds the Lifetime Allowance. A test only happens on a benefit crystallisation event such as a withdrawal.

It’s important to remember that the test applies to the value of the total amount you are accessing, not just the lump sum or income amount that is paid to you. Your withdrawal uses up a percentage of your Lifetime Allowance.

If you decide to take your pension benefits in stages, you will use up a proportion of your Lifetime Allowance each time you take benefits. It’s likely in this situation that you will have one or more benefit crystallisation events.
The value of your pension depends on the type of scheme you have:
• If you have a defined contribution (money purchase) pension, the value of your benefits is the value of your pension pot.
• If you have a defined benefit (final salary) pension, the value of your benefits is typically calculated as 20x the pension that you have accrued under the scheme plus any tax-free cash that you received.
Essentially, when you come to draw your pension, or at age 75, a test is done to establish whether the value of the benefits you have accrued is more than £1,073,100. If it is, you are likely to have to pay a tax charge.

Why the Lifetime Allowance matters to you.

If you have a pension with a value approaching or over the Lifetime Allowance, this may be an immediate concern.
The Lifetime Allowance tax charge depends on how you access the excess amount above the Lifetime Allowance. The charge is:

• 55% if you take benefits as a lump sum
• 25% if you take benefits as income.

As you can see, this is a significant amount. You could lose more than half of your withdrawal to tax. This could naturally affect your level of income in retirement.

You might think that, at £1,073,100, the Lifetime Allowance only affects the super-wealthy. However, as pensions are normally a long-term commitment, even a relatively modest pension fund today could exceed the Lifetime Allowance by the time you want to take your benefits.

Bear in mind that, according to figures from insurer Canada Life, a pension value of £1,073,100 today would only secure an annual income of around £28,000 a year at age 65.

We’ll look more about how easy it could be to breach the Lifetime Allowance, and what you can do if you’re worried about exceeding the allowance, in our next blog.

In the meantime, if you’re concerned about your pension and the Lifetime Allowance – particularly considering the freeze in allowance until 2026 – please get in touch. Contact us today or call 01372 404417.

Please note:

A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The value of your investment (and any income from them) can go down as well as up which would have an impact on the level of pension benefits available.

Your pension income could also be affected by the interest rates at the time you take your benefits. The tax implications of pension withdrawals will be based on your individual circumstances. Levels, bases of and reliefs from taxation may change in subsequent Finance Acts.

Reviews and Ratings for Financial adviser Ray Martin, Kingston-upon-Thames

We’re highly rated

We retain a 5-star rating on VouchedFor, an independent service that enables clients to review their professional advisers. VouchedFor verifies the reviews and testimonials we receive, so you can be confident that they are authentic. 2018, 19, 20, 21, 22 and 23 Top Rated Adviser, as listed in The Times

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Our former financial adviser was retiring and recommended Ray to us. He alleviated the constant worry of where to best invest our savings without too much risk. We’re very pleased with the results over the last 10 years. He explains things in layman's language, which we appreciate, and gives us the confidence we have made the right choices. What more can people expect?


We had pension policies and investments that needed sorting out ready for retirement. We didn't know what to expect from a financial adviser. We assumed that he would simply advise us where to get the best deals. How wrong we were. Ray took us right back to basics. He made us carefully consider what we really wanted to achieve. He has allowed us to start to really enjoy our retirement.


I needed financial advice about pensions and investments as I approached retirement. My wife was in the same position. Ray Martin worked out a comprehensive plan for putting my pension provision and savings into proper order. He did the same for my wife. He has continued to provide us with advice ever since. Ray is always straightforward, open and proactive.


I was approaching retirement and wanting to look into limiting taxation and Inheritance Tax, as well as providing for my wife. Ray provided sound advice to switch from my current arrangement to a Drawdown Pension and ISA investments. I have now retired and have started seeing the benefits of his advice. The returns on my portfolio have increased beyond expectation. Ray performed extremely well.


I had sold my house and didn't know how to invest the money. Ray invested very wisely and there has been about a 5% increase every year. He listened to our queries, gave answers that we fully understood and followed any requests. He always had time for us, and never rushed us. We would have been financially at a loss without his help.


Ray has been advising my wife and me for about 20 years. He is everything one could hope for in a financial adviser: wonderfully enthusiastic, extremely well informed, completely trustworthy and scrupulously observant of the regulatory requirements. He is able to explain complex matters very clearly, and so far, his advice has always been first class.


I had money to invest and had no idea how to go about investing it and hopefully making a gain. I have three children and wanted advice about inheritance planning. Ray is very patient, very clear when he explains things, he is very interested in me as a person, totally trustworthy and is an excellent listener. We have never been disappointed! He`s been brilliant.


I had just been widowed. Ray sorted out and simplified what was a very complex set of investments into a much less confusing portfolio. I have been extremely happy with everything Ray has advised over the last 12 years. Whilst moving with the times, he has dealt with all aspects of my investments wisely and given me all the guidance and help I have needed.


As the financial director of a company, I was seeking to get advice on how to plan and invest for retirement. Without a doubt, Ray Martin helped me understand and plan how to fund my retirement. Ray has been with me every step of the way. His advice has been invaluable. I retired and achieved my annual income goal. His continued advice is helping me in the next stage of my life.


I needed some advice regarding my late mother’s estate. I had also retired and required advice on how to manage my private pension. Ray was extremely helpful, and his advice was very clear and easy to understand. I came away from our initial meeting feeling very relieved and less stressed. We have just had our first yearly review and I was surprised how well my investments had done.


In the last 10 years, my circumstances have changed with the passage of time. Ray has guided me on how to protect and make my money grow. He listens carefully to my needs and gives clear, concise advice in a professional manner. He and his team are always accessible and patient with my questions and their approach gives me confidence that my finances are securely looked after.


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