Pension Lifetime Allowance is frozen until 2026: Will it mean your retirement tax bill soars?

While the chancellor didn’t announce personal tax rises in this year’s budget, a freeze on allowances could mean your tax bill unexpectedly increases. High earners and those with defined benefit (DB) pensions could now find they exceed the Lifetime Allowance, as it will remain frozen until 2026.

The Lifetime Allowance is the amount you can tax-efficiently save into a pension. It was expected to rise in line with inflation, but the allowance will now remain at £1,073,100 for the next five years.

That sum sounds like a lot, but it can be easier than you think to exceed the threshold. The Lifetime Allowance applies to the total value of your pension, not just the contributions you’ve made. Once you factor in employer contributions, tax relief, and investment returns over several decades, you could end up closer to the threshold than you expect.

If you have a DB pension, you’ll need to take the value of the pension you’ve accrued and multiply this by 20 to work out if you’re nearing the Lifetime Allowance. The freeze is likely to affect you if you’re on track for a pension of more than £53,655 a year.  

While the Lifetime Allowance is remaining the same, the freeze means more people will pay additional tax. According to the government’s policy costing document, the freeze will boost the Treasury coffers by £990 million.

Exceeding the Lifetime Allowance could lead to a 55% tax charge

If you do exceed the Lifetime Allowance, you will pay more tax:

  • Any amount over the Lifetime Allowance that you take as a lump sum is taxed at 55%.

  • Any amount over the Lifetime Allowance that you take as an income, for example, to buy an annuity or access through flexi-access drawdown, is taxed at 25%. This is on top of any Income Tax payable in the usual way.

The additional tax can mean your retirement savings don’t go as far as expected. It’s important you understand whether you’ll exceed the Lifetime Allowance, so your wider financial plan reflects potential tax charges. While it can be tempting to stop pension contributions if you’re nearing the threshold, this doesn’t always make financial sense.

But don’t automatically stop pension contributions if you’re nearing the Lifetime Allowance

A pension can still make financial sense

While no one wants to pay extra tax, continuing to contribute to a pension beyond the Lifetime Allowance can make financial sense. Your contributions are still invested and will grow free from Capital Gains Tax. Depending on your circumstances, this can be useful.

You’ll still benefit from employer contributions

While you’re contributing to a pension, your employer usually must too. These contributions are also invested, hopefully delivering returns. So, despite the additional tax charge you can end up better off overall.

You could be giving up other benefits

Finally, some pensions come with valuable benefits that you would be giving up if you stopped contributing. This may include a pension for your spouse, civil partner, or children if you passed away, providing your loved ones with financial security. Before you decide to stop contributing to a pension you should carefully weigh up the benefits, whether they’re valuable to you and how you’d replace them if needed.

Weighing up the Lifetime Allowance with your retirement in mind

While in most cases halting pension contributions completely isn’t advisable, there are often things you can do to reduce the amount of tax you’ll pay when you retire. These may include:

  • Reducing pension contributions

  • Withdrawing your excess pension as an income, not a lump sum

  • Applying for Lifetime Allowance protection where applicable.

The most important thing is to consider your circumstances and priorities to create a retirement plan that suits you. Please contact us if you have any questions about the Lifetime Allowance freeze and what it means for your pensions. We’ll work with you to put a plan in place to minimise tax liability while remaining on track to secure the retirement you want.

Please note: This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.

A pension is a long-term investment. The fund value may fluctuate and can go down, 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, tax legislation and regulation which are subject to change in the future.

Ken Simmonds