What is the pension lifetime allowance and how does it work?

The lifetime allowance (LTA) was the maximum amount you can build up in your pensions without paying extra tax.

It was abolished on 6 April 2024, and new allowances have been introduced to provide clarity on tax-free benefits and transfer limits.

We’ll explore what replaced the LTA later in this article.

What was the pension lifetime allowance?

The lifetime allowance was the maximum size you could allow your pension pots to grow to without facing an additional tax charge. This limit was previously £1,073,100.

If you had any final salary (defined benefit) pensions, it could be a little more complex to calculate your LTA, as this kind of pension doesn’t involve a fixed pot of money.

The LTA shouldn’t be confused with the annual allowance, which is the amount you can pay into any pensions in a single tax year.

What replaced the lifetime allowance?

The lifetime allowance was replaced by the lump sum allowance (LSA) and lump sum and death benefit allowance (LSDBA).

The LSA allows you to take 25% of your pension as a tax-free lump sum, up to a total of £268,275 across all your pensions.

The LSDBA permits tax-free lump sums and death benefits up to £1,073,100, with any excess taxed at either yours or your beneficiaries' marginal rates.

The overseas transfer allowance (OTA) is also set at £1,073,100, applying to transfers to overseas pension schemes. These allowances may be higher for those with LTA protection.

How did the pension lifetime allowance work?

If your pensions were collectively worth more than the LTA, you would usually face an extra tax charge. How much this charge was depended on how much you exceeded the limit and how you took your pension.

Note that the LTA was defined as the amount you can build up in your pensions without getting hit by a tax charge.

This took into account pension pot growth and other factors such as tax relief, so it meant it was possible to exceed the LTA by accident.

If you suspected your total pension savings were approaching the limit (including any final salary pensions), then you would have needed to seek financial advice to work out how much you could continue to save.

What were the pension lifetime allowance changes?

The LTA was significantly reduced in recent years before it was abolished.

Before 2006, there was no limit to how much people could save into pensions.

When the LTA was introduced, the allowance was £1.5 million, and rose to a peak of £1.8 million by 2010/11 before starting to fall. It hit a low of £1 million in 2016/17 before rising again to the level of £1,073,100 from 2020/21.

In his 2023 Spring Budget, Jeremy Hunt announced the LTA would be removed from April 2023 before being scrapped entirely from April 2024. However, if you hold a valid LTA protection that is valid on or before 5 April 2024, you may still benefit from higher tax-free lump sums.

What happened if my pension exceeded the lifetime allowance?

If your pension exceeded the LTA, your pension provider would have let you know in writing. Any extra tax you owed would have been deducted from your pension by your provider before you received the money.

You would have needed to report this tax on your self-assessment tax return.

How much was the tax charge for exceeding the lifetime allowance?

You would have paid an extra tax charge on the excess amount above your LTA. For example, if your pension pot totalled £1,200,000, the excess was £126,900.

This amount was then taxed at either 55% (if you took it as a lump sum) or 25% if you took it any other way (e.g., through drawdown, uncrystallised funds pensions lump sum (UFPLS), or buying an annuity). So, your additional tax bill would have been either £69,795 or £31,725.

When was my pension tested for the lifetime allowance?

You could have asked your pension provider at any time to let you know how close you were to your LTA. If you had more than one pension pot, you would have needed to contact all your providers (and made sure you had tracked down any forgotten pensions, too).

Your provider would have let you know in any case when you decided to start drawing your pension.

How do I calculate the value of my pensions?

You could have asked your pension provider(s) to give you an up-to-date valuation of your pension, but you needed to track down all your current pension pots, as you might have some from early employment that you’ve forgotten about

Also, bear in mind that the value of your pension may fluctuate with the stock market – a sudden rise in the markets might have benefitted your fund and push you accidentally over the allowance if you are already close to it.

If your pension pots weren’t all with one provider, you might have needed the help of a financial adviser to get a reliable valuation.

How do I calculate my LTA if I had final salary pensions?

Calculating the value of a final salary (defined benefit) pension for LTA purposes was slightly more complex. This is because a final salary pension is not a fixed pot of money but a guaranteed annual income for the rest of your life.

In most cases, if you knew the annual amount of your pension, you could have worked out its total value by multiplying that figure by 20 (because the average person is expected to live 20 years from the date of starting to draw their pension).

Note that this isn’t the ‘real’ total value of the pension for any other purposes.

If you lived longer than 20 years, it would pay out more, and if you didn’t live that long, it would pay out less. Similarly, if you were transferring your pension, its transfer value may well be more than that (though it’s unlikely to be less).

What could I do if my pension was approaching the allowance?

If you were worried that continuing to save into your pension could cause it to exceed the lifetime allowance, you could have talked to your pension provider and a financial adviser.

Your options might have included either opting out of your workplace pension or simply continuing to save and paying the tax charge.

Which option worked out as the best value for you may have depended on your circumstances, so financial advice would have been important here.

Could I protect my lifetime allowance?

If your pension savings were above the current lifetime allowance in the tax year 2015/2016 but below the lifetime allowance at that time (£1,250,000), then you could have applied for individual protection in 2016.

This protection meant your pension savings would have been measured against your lifetime allowance as it was then.

Speak to your financial adviser to find out more, particularly if you already have a protection in place, as these can provide higher tax-free lump sums than the new allowances.

Where can I get pension lifetime allowance advice?

Any financial adviser specialising in pensions will be able to advise you on issues relating to the lifetime allowance.

FAQs

Who paid lifetime allowance charge on death?

If you died before taking your pensions, your beneficiaries would have had to pay any tax charge due as a result of exceeding the LTA.

With the LTA now abolished, they will instead need to be aware of the lump sum and death benefit allowance (LSDBA) limits.

What happened to my lifetime allowance during a divorce?

If a pension was to be shared between the ex-spouses following a divorce, then the amount each received would have been counted towards their own lifetime allowance.

This might have been of particular concern to the ex-spouse who was not the original holder of the pension, as if they already had pensions of their own, their share of the split pension may have pushed them above the LTA.

Were tax free lump sums included in the lifetime allowance?

Previously, your total pension savings were assessed for the LTA before you started to draw them. With the LTA scrapped, focus now shifts to the LSA, which governs the amount you can take tax-free.

Get expert financial advice

With the pension lifetime allowance abolished, you have greater flexibility in saving for retirement without worrying about exceeding a tax threshold.

The introduction of new allowances like the LSA and LSDBA provides guidelines on tax-free benefits and transfer limits.

Staying informed and working with a financial adviser can help you make the most of these changes and ensure your retirement planning remains on track.

Unbiased will match you with a financial adviser for expert financial advice on navigating the new pension allowances and optimising your retirement savings strategy.