The Lifetime Allowance is the maximum you can save in your pensions over your lifetime, without having to pay any extra tax charges when you take money out of them. It ignores any income coming from the State Pension.

How much is the Lifetime Allowance for 2022-23?

The pensions Lifetime Allowance in the 2022/23 tax year is £1,073,100. Rather than rising in line with inflation as it has in previous years, the Chancellor announced in the March 2021 Budget that the Allowance will remain at this level until the 2025/26 tax year.

The Lifetime Allowance might sound an enormous amount – and of course by most people’s standards it is – but those who’ve saved into a pension over the course of several decades may find they end up with retirement savings in excess of this amount, especially if they’ve been lucky enough to belong to a final salary (or defined benefit) pension scheme. With this type of pension, you’ll receive a guaranteed income at retirement, which is usually based on how many years you’ve belonged to the scheme and a proportion of your final year’s pay. 

Here, we explain how the Lifetime Allowance works, and how freezing the level of the allowance could start to affect growing numbers of taxpayers.

Why has the Lifetime Allowance been frozen?

The Lifetime Allowance has been frozen to generate more revenue for HMRC. Keeping it at its current level until 2026 is expected to raise £990m for Treasury coffers through a process known as ‘fiscal drag’ – where the threshold no longer rises in line with increases in living costs and inflation. The allowance will therefore be much lower by 2025/26 than it might otherwise have been, resulting in more people potentially ending up with a tax bill. 

Jason Whyte, associate life and pensions partner at accountants EY, said: “Freezing the Lifetime Allowance will help the Chancellor to reduce the ‘cost’ of higher rate tax relief – not much in the short term, but quite a bit by the end of the 2025-26 tax year. It may also turn out to be a precursor to more comprehensive pension reform in the future.”

“The Lifetime Allowance affects high earners and those approaching retirement age the most, including those with defined benefit pensions. As the value of high earners’ pensions rises over the next five years towards a lifetime limit that will remain fixed, more and more individuals will find they need to stop contributing to avoid breaching the limit.”

“The Lifetime Allowance is seen as a key mechanism to limit future tax relief bills that only impact a small segment of the population, but it is not without challenges. It affects long term savers who have made good investment decisions as much as it does high earners, and it also affects those in final salary schemes – many of whom are senior officials in the NHS or public sector.”

What happens if my pension savings exceed the Lifetime Allowance?

If the value of your pensions is higher than the Lifetime Allowance, you’ll have to pay a tax charge on anything above it, and you should get a statement from your pension provider which will show how much tax you owe.

The amount you’ll be charged depends on how you’ve chosen to take money out of your retirement savings.

What are the charges if you exceed the Lifetime Allowance?

Any amount over your Lifetime Allowance taken as a lump sum, for example, will be taxed at a flat rate of 55%, whereas if you make cash withdrawals via drawdown or receive the money as regular pension payments, instead of the flat rate of 55%, you’ll be taxed an additional 25% on top of any regular income tax payable on your pension income.

If, for example, if you want to crystallise your pension and take a £10,000 lump sum from it, and it has a value of £1,083,100, tax will be applied to the £10,000 which is in excess of the £1,073,100 Lifetime Allowance. If you take the £10,000 as a lump sum you’ll pay £5,500 tax (55%), but if you take it as income through drawdown or an annuity you’ll pay £2,500 (25%), plus income tax.

There are various other pension allowances you need to get to grips with too. For example, in addition to the Lifetime Allowance, there is also a pensions Annual Allowance, where most of us can pay up to a maximum of £40,000 a year into our defined contribution pensions. However, once you’ve started taking money out of your pension, this Annual Allowance falls from £40,000 to £4,000 and becomes known as the Money Purchase Annual Allowance (MPAA). You will still receive tax relief on any new top up savings up to the £4,000 limit. You can learn more about how the various pension allowances work in our article Understanding your pension allowances.

Can I protect my pension Lifetime Allowance?

If you have pension savings over and above the current pension Lifetime Allowance, you could be left with a large tax bill, so it’s a good idea to keep a close eye on your pots to make sure you don’t fall into the wrong bracket. 

The good news is that rather than just monitoring your pension pots for yourself, you may be able to apply for a level of protection from the Lifetime Allowance limits. This effectively allows you to have a higher allowance threshold, meaning more of your money is protected from hefty taxation. These protections have been designed in recognition that many people would have saved into their pension pots expecting a much higher allowance.

Over the years there have been a number of different types of protection which continue to function for anyone that holds them, but if you want to apply for protection now, the two main types of protection you might be eligible for are:

Individual protection 2016

If you had over £1m in your pension savings on 5 April 2016, you could be eligible for Individual protection which will provide you with a Lifetime Allowance protection of £1.25 million or the value of your pension savings at 5 April 2016 (whichever is lower).

The key point that differentiates individual protection from fixed protection is that you can continue to add to your pension, but must pay tax on money taken from your pensions that exceed your protected Lifetime Allowance.

If you previously had enhanced protection or fixed protection (including fixed protection 2014 and 2016), you can still apply for individual protection. However if you had either primary protection or individual protection 2014, you will not be eligible to apply.

Fixed protection 2016

You can apply for fixed protection 2016 if you or your employer have not added to your pension savings since 5 April 2016 or if you opted out of any workplace schemes by 5 April 2016.

Fixed protection effectively fixes your Lifetime Allowance at £1.25 million, but you will no longer be able to contribute to your pension. If you put any money into your pension after you’ve got fixed protection, you will lose it and you will need to pay taxes on the excess.

If you previously had enhanced protection, primary protection or fixed protection (including fixed protection 2014 and 2016), you will not be able to apply for fixed protection 2016. 

How can I apply for protection?

You can apply for either of the above protections through the government’s website. Before you apply, it’s worth knowing that you will need a few pieces of information, including a Government Gateway user ID and password. You may also need to know what your pension savings were at 5 April 2016, as well as a breakdown of this.

If you do not have this information, it is a good idea to collect it all before you start. You can ask your pension administrator for information relating to your pension and can apply for a Government Gateway when you apply.

How is the Lifetime Allowance tax charge paid?

If you have a defined contribution pension, and you are taking your money via regular drawdown, your scheme administrator will usually pay the 25% you owe to HMRC out of your pension. Similarly, if you decide to take a lump sum that is in excess of the Lifetime Allowance, your pension scheme administrator should deduct the charge on your behalf and pay it to HMRC. If you have a defined benefit pension, your pension scheme may choose to pay the tax on your behalf but then reduce your pension to cover this cost but you will need to check with your provider.

What if I’m near to going over my Lifetime Allowance?

If you’re close to exceeding the Lifetime Allowance, you will likely want to get advice from a qualified financial adviser. Some people suggest reducing returns on your pension savings, for example, by moving your money into lower risk, lower return cash holdings  so you don’t breach the limit. Others choose to look at other tax efficient saving opportunities such as ISAs, or even Venture Capital Trusts and EIS investments into smaller companies. It’s a highly complex area however, where it will almost certainly pay to get tailored professional advice for your personal circumstances in order to avoid falling foul of the rules and incurring a hefty tax charge.

If you’re 50 or over and have a defined contribution pension, you can get free guidance on the options available to you from the Government’s Pension Wise service. You may also want to get in touch with the Pensions Advisory Service.

Nick Hill, money expert at the Money and Pensions Service, who deliver the Pensions Advisory Service, said: “The freeze on the pensions Lifetime Allowance could impact those who have pension benefits that are approaching, or above, the lifetime allowance, though it is set at a high level so it won’t affect most people. If you think you will be impacted, you can speak to our pensions specialists by calling 0800 011 3797 or visiting the Pensions Advisory Service Website.”

However, if you want personal recommendations or advice about your specific circumstances, you’ll need to seek professional financial advice. You can find a local financial advisor on VouchedFor or Unbiased, or for more information, check out our guides on How to find the right financial advisor for you or How to get advice on your pension.

If you’re considering getting financial advice and are looking for somewhere to start, Rest Less Pensions are offering a free Pension Health Check with one of their experts. They can offer you information and guidance on the call and at the end will discuss whether you would benefit from paying for professional financial advice. Capital at risk.

Have you triggered the Lifetime Allowance or does it worry you that the Lifetime Allowance has been frozen? We’d be interested to hear from you. You can join the money conversation on the Rest Less community or leave a comment below.


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