What is the purpose of the £1074000 life time allowance?

16 September 2021

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Question by Andy

What is the purpose of the £1074000 life time allowance? Is it that HMRC considers this more than enough for your typical pensioner to need before they die? My SIPP is growing on average at £30000 a month currently and I intend to live to 100, so I reckon I'm heading for a good tax thumping. Opinions/options anyone?

Answered by Jeannie Boyle

The cynical answer to your question is it's a tax on investment growth. One that the government has been able to increase significantly over the last 10 years without any political fall-out. People with £1million in a pension don't elicit much sympathy in the press. The official answer is that the Lifetime Allowance caps the amount you can accumulate in the tax advantaged pension wrapper.

The other fact about the Lifetime Allowance that cynics will note is that it very rarely applies to people in Final Salary pensions. You'd need a final salary pension of over £50,000 per annum to be caught by the Lifetime Allowance charge. £1million in a defined contribution pension would only buy c.£30,000 of guaranteed income on the same basis (age 65, 50% for your spouse, inflation linked).

Headlines tend to focus on the Lifetime Allowance charge being 55%. This only applies if you opt to take your excess (the amount that is over the Lifetime Allowance) as a one-off lump sum. If you leave the excess in the pension in order to draw it gradually as income, then the tax charge is 25%. You do still pay Income Tax in the normal way on these withdrawals so if you're a 40% taxpayer then the net effect is the same.

Your pension is measured against the Lifetime Allowance twice: the first time you take any money out and again at age 75. The second test checks how much the fund has grown since the first test and taxes that growth. To avoid this you can simply withdraw the growth every year. The downside to this strategy is that you might pay more income tax and if you don't spend the withdrawals they could be subject to Inheritance Tax.

For some people crystallising their pension earlier they intended can help reduce the amount of Lifetime Allowance they pay. Trying to reduce the Lifetime Allowance can be a game of 'whack-a-mole'. You might reduce the Lifetime Allowance tax charge, but you pay more Income Tax or Inheritance Tax as a result.

Some people change their investment strategy. They take less risk with their pension in order to keep the growth low, but compensate for this by dialling up the risk on non-pension investments. In theory, the net position should be the same. Unless you have a substantial ISA portfolio, this will lead to more tax elsewhere.

Everyone's situation is different, so it is best to take advice based on your own circumstances. You might also benefit from some cashflow planning to make sure you can sustain your lifestyle up to age 100. It would make sure you aren't spending too much or too little.

Answered by

Jeannie Boyle

Chartered Financial Planner

I'm a Chartered Financial Planner & Fellow of the Personal Finance Society. I work with people in Brighton, London & anywhere in between. My specialism is helping people align their money with their values. Many of my clients share my commitment to protecting the environment and investing to create a better future for our planet. My company, EQ Investors, has won multiple awards for our Positive Impact Portfolios and I have personally been recognised as a leading adviser in this sector.