Too embarrassed to ask: what is the lifetime allowance?

If you have been saving into your pension for some time now you may have heard the term "lifetime allowance". Here's what that means.

One of the most popular long-term savings vehicles in the UK is the pension.

A pension is a tax-efficient wrapper for your investments. If you invest using a pension, you will pay less tax than you would if you invested without using the wrapper. 

These tax benefits are designed to encourage us to save enough to fund our own retirements, rather than depend on the state in our old age. However, the tax benefits of pensions have become steadily less generous over the last 20 years. 

Governments have shied away from directly cutting tax relief on pension contributions, presumably because they fear it would be too politically controversial.  Instead they have drastically cut the amount you can save into a pension. 

As well as limiting the amount you can save each year, they have imposed a lifetime allowance on the total amount you can shelter in a pension. Currently, this lifetime allowance is just over a million pounds. 

If the total amount of money in your pension goes above that – even if it’s down to strong investment performance rather than your contributions – then you will have to pay a punitive rate of tax on the excess when you come to take it. 

A million pounds might sound like a lot of money. It is a lot of money. However, if you are hoping to fund a 30-year retirement, it might not be as much as you think. 

At current annuity rates, one million pounds would buy a 65-year old single man an inflation-linked income somewhere in the region of £30,000 a year for life. That’s enough to be comfortable, but it’s not going to fund a millionaire’s lifestyle. 

It’s also worth noting that the lifetime allowance has mostly gone down, rather than up, since it was introduced. It started at £1.5 million in 2006, rose as far as £1.8 million by 2011, then was cut to £1 million in 2016. It now stands at just over one million and seventy thousand pounds.  

In other words, there is no guarantee whatsoever that it will rise with inflation in the future. 

So if you are in your 40s or 50s, it’s worth planning ahead now. And if you are closer to retirement and are concerned that you may breach the lifetime allowance, it’s worth seeking advice. 

The rules are more lenient for people with defined benefit pensions. To learn more about that and about efficient pension investing, subscribe to MoneyWeek magazine.

Recommended

Julian Brigden: markets are at a huge inflexion point
Investment strategy

Julian Brigden: markets are at a huge inflexion point

Merryn talks to Julian Brigden of Macro Intelligence 2 Partners about the unwinding of the US stockmarket's super-bubble, and the risks and opportunit…
25 Jan 2022
Has growth investing had its day? Don’t be so sure
Growth investing

Has growth investing had its day? Don’t be so sure

Markets – and “jam tomorrow” growth stocks in particular – continue to crash, with some analysts forecasting a 50% drop or more. But, says Max King, a…
25 Jan 2022
A cheap investment trust with a good record
Investment trusts

A cheap investment trust with a good record

This cheap investment trust’s yield of almost 9% may look too good to be true, but should be sustainable, says Max King.
25 Jan 2022
Tax return deadline extended – but don't forget to file
Income tax

Tax return deadline extended – but don't forget to file

HMRC is being slightly more lenient about tax returns this year, but falling behind will still incur hefty fines.
25 Jan 2022

Most Popular

Shareholder capitalism: why we must return power to listed companies’ ultimate owners
Investment strategy

Shareholder capitalism: why we must return power to listed companies’ ultimate owners

Under our system of shareholder capitalism it's not fund managers, it‘s the individual investors – the company's ultimate owners – who should be telli…
24 Jan 2022
Ask for a pay rise – everyone else is
Inflation

Ask for a pay rise – everyone else is

As inflation bites and the labour market remains tight, many of the nation's employees are asking for a pay rise. Merryn Somerset Webb explains why yo…
17 Jan 2022
Three innovative Asian stocks to buy now
Share tips

Three innovative Asian stocks to buy now

Professional investor Fay Ren of the Cerno Pacific Fund highlights three of her favourite Asian stocks to buy now
24 Jan 2022