I’m a high earner and considering retirement. Can you explain the lifetime allowance to me? Stephen Hill, senior partner with S Hill & Co replies:
The lifetime allowance is the maximum value of your pension fund before tax penalties are applied on retirement. The lifetime allowance is £1.8m for the 2010/11 tax year and Her Majesty Revenue & Customs has recently announced that this will be reduced to £1.5m for the tax year 2012/13.
At the time of payment, a recovery charge will be applied to the value of retirement benefits in excess of the lifetime allowance. The amount will depend on how the excess is paid. For instance, if the pension is paid as a lump sum, any excess will attract a one-off 55% recovery charge. If it is to be paid as a regular pension, the excess will be subject to a 25% tax charge and income tax also be applied.
While £1.5m is still a considerable pension pot that most people would not be able to achieve, we often see clients with long service in final salary schemes such as doctors and dentists whose pension funds are close to this figure.
HMRC did offer several ways to protect yourself from these charges if you are expecting to be over the lifetime allowance but the deadline to apply for primary or enhanced protection is now over.
It’s essential therefore to monitor the value of your pension fund when close to retirement. For some clients, this may mean changing the funds their pension is invested in as too much growth may actually create a tax charge. As ever, if you have regular financial reviews with your adviser, none of these changes will come as a shock and can be planned for.