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Tax on Pension Income
Any amount over your lifetime allowance that is taken as a regular retirement income – for instance by buying an annuity – will attract a lifetime allowance charge of 25%. This is on top of any tax payable on the income in the usual way.
How much is the lifetime allowance?
The lifetime allowance for most people is £1 million in the tax year 2016-17. It applies to the total of all the pensions you have, including the value of pensions promised through any defined benefit schemes you belong to, but excluding your State Pension.
From 6 April 2018, the government intends to index the standard Lifetime Allowance annually in line with the Consumer Prices Index (CPI). For defined contribution pension schemes, your pension scheme administrator should pay the 25% tax to HMRC out of your pension pot, leaving you with the remaining 75% to use towards your retirement income.
How does the tax work?
Suppose someone pays tax at the higher rate and expects to get £1,000 a year as income but the 25% lifetime allowance reduced this to £750 a year. After Income Tax at 40%, the person would be left with £450 ( i.e £750 * 60%) a year. This means the lifetime allowance charge and Income Tax combined have reduced the income by 55% [ ( i.e £1000 - £450)/£1000 ]%, which is the same as the lifetime allowance charge had the benefits been taken as a lump sum instead of income.
For defined benefit pension schemes, your pension scheme may decide to pay the tax on your behalf and recover it from you by reducing your pension.
Can we avoid the lifetime allowance?
If you wish to avoid the lifetime allowance charge it’s important to monitor the value of your pensions, and especially the value of changes to any defined benefit pensions as these can be surprisingly large
You may also wish to consider applying for protection if your pension savings is expected to exceed the lifetime allowance threshold.
If you need clarification on any of the above, contact us