The Chancellor’s decision to freeze the Lifetime Allowance (LTA) at £1,073,100 (for 2020/21), in the recent budget is causing our medics some concern. Especially, when most of us were expecting the limit to rise with inflation. Many doctors & dentists live in fear of hitting their lifetime allowance due to the tax penalties this brings.
Is breaching your LTA as bad as it seems?
An increasing number are sensibly seeking our advice as to whether they need to come out of their NHS pension scheme early to alleviate this possible tax liability. Let’s look at the facts and how the lifetime allowance is applied and the common errors when calculating your own allowance.
Firstly, what is Lifetime Allowance?
First launched in 2006, LTA seeks to cap the maximum amount that you are allowed to hold in a pension environment over the course of your lifetime. More accurately, it restricts the income and lump sums that can be drawn from your pension environment. I am tempted to go off on a tangent, arguing how it is in effect a tax on growth, but I’ll save that for another day!
The common mistakes when assessing the lifetime allowance:
- Many people mistake the hypothetical annuity cost as the lifetime allowance figure.
- GDP’s and GMP’s it is not the lifetime dynamised earnings.
- Don’t forget if you are looking to draw your pension early it will suffer abatements and therefore reduce how you are measured against the lifetime allowance.
- Scheme pays elections will reduce the lifetime allowance.
Should you be concerned about breaching your lifetime allowance?
Ultimately, if you breach your LTA you will end up with a bigger pension, despite the lifetime allowance. It is important to understand how they apply this penalty as it may not be as punitive as you first imagined.
So how does it work?
Firstly, it is only the figure that is over your pension lifetime allowance that is subject to the lifetime allowance tax charge.
When taken as income, the amount over the LTA has a 25% tax penalty applied, so on a £100,000 breach in excess of the LTA, that figure would equate to £25,000. You do not pay this as a lump sum. It just reduces your pension. They apply an actuarial factor that varies with age. At age 60 this factor is in the region of 20. (It’s also worth noting that the actuarial factor lowers as you get older, as the pension will not pay out as long).
You then divide the £25,000 by the actuarial factor (let’s assume 20), resulting in £1250. It is worth noting that this £1250 charge would be subject to income tax, so the impact to your annual income after income tax would be £1000 or £750 p.a. depending on if you were on the basic or higher rate tax, respectively.
So the headline of a £100,000 breach actually equates to a monthly reduction of your pension of £83 or £62 (basic and high rate tax).
I know it would be better without a breach but it’s not as scary as it first seems!
What if you have a private pension?
Lifetime allowance does become more complex if you have a private pension, as the order in which you draw your private pension and the NHS pension matters hugely. You should seek advice so you fully understand the implications and your options to pay the increase in tax liability.
Hopefully, we have eased your concerns a little and you see the repercussions are not as bad as you initially thought! Although breaching your lifetime allowance is not ideal, we urge you to always look at the bigger picture. Everyone’s circumstances are unique, so you really need to think carefully before giving up all the benefits an NHS pension scheme has to offer.
If you need further assistance with your pension, please feel free to contact one of our specialist financial advisers.
Does this explain lifetime allowance a little more, and make hitting it seem a less daunting? Lets us know by leaving a comment below