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.

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