Pension Lifetime Allowance
Each UK tax payer can save a maximum of £1,055,000 (19/20 tax year) into their pension during their lifetime. This amount has been index-linked to CPI since 2018 and is re-assessed on the 5th of April in each new tax year.
Should your pension value exceed this amount, there could be a hefty tax of 55% to pay when you come to use the funds in retirement. It is important to understand how and when your pension is tested against the lifetime allowance.
Uncrystallised or Crystallised?
When you are paying into your pension, the funds status is classed as “uncrystallised”. When the pension is classified in this way it will not be tested against the lifetime allowance until you reach age 75. This means that even if the value increases above the lifetime allowance, no tax will be due as the funds are still uncrystallised.
Should you decide to take the tax-free cash or place the pension into drawdown, these events would mean the pension is reclassified as “crystallised”. At this point, the pension would be tested against the lifetime allowance.
The test is carried out by adding all of the pensions you hold, including any tax-free cash that may have been taken in the past, to create a total pension value. This is then measured against the pension lifetime allowance and any excess will be taxed in one of two ways:
1. You can withdraw the excess as a lump sum and pay 55% tax.
2. You can leave the excess in the pension to be used to generate income for your retirement, and in this case a lower 25% tax would be applied.
It is important to note that you don’t need to test the full value of the pension against the lifetime allowance at the same time. You can choose how much is tested and this creates the chance to delay any lifetime allowance charge should you wish to.
For example, if you have a pension of £1.2 million and want to start taking benefits from it, you could opt to enter just the £1,055,000 into drawdown rather than the full £1.2 million. This would mean no lifetime allowance would be due, as you have only crystallised up to the lifetime allowance limit. The remainder can be delayed until you reach age 75.
Age 75 test – As a long stop, all pensions will be tested against the lifetime allowance once you reach age 75. This stops you delaying the lifetime allowance charge indefinitely.
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