The March 2015 Budget introduced that the pension lifetime allowance will reduce to £1 million from April 2016.

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These changes will be important to you if your existing pension funds are near this level, or are likely to do so in the future.

Key points:

  • Pension lifetime allowance to reduce from £1.25 million to £1 million from April 2016
  • Transitional protection to be available
  • From April 2018 the lifetime allowance will increase by CPI annually

About the pension lifetime allowance

The pension lifetime allowance is the maximum amount you can hold in pension plans. If your pension plans are worth more than this limit, any excess will be taxed at 25% on the excess if it is taken as an income (in addition to the usual income tax payable on the income). If the fund is taken as a lump sum the excess charge is 55%. This makes it important to understand if your pensions are likely to go over the lifetime allowance.

The lifetime allowance is different to the annual allowance, which is the total you can pay in to pensions each tax year.

Are your pension benefits likely to exceed £1 million?

How to calculate your pension benefits

When you take your pension benefits you go through a benefit crystallisation event (BCE). This means your pensions move from the accumulation phase to the income phase. At that point you must assess these benefits against the current lifetime allowance.

For money purchase schemes (like personal pensions), this will be the total value of your pension funds.

For final salary schemes this will be 20x the accrued income, plus the tax-free lump sum.

Reducing the lifetime allowance from £1.25 million to £1 million

Obviously, the lifetime allowance will not affect most people. If your pension funds are near to this figure, or you are paying in significant funds, you may reach the lifetime allowance limit in the future.

The changes will not come into force until April 2016, and transitional protection is planned for those whose funds are between £1 million and £1.25 million. If this applies to you, you may be able to ring-fence the pension funds so that the excess tax charges do not apply to you. However, the pay-off will be that you will not be allowed to make further contributions to your pensions in the future.

What to do next

Take a look at our article on retirement income.

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