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A lifetime allowance tax charge is what you will pay if the value of your pension exceeds the Lifetime Allowance. In the UK, the Lifetime Allowance is currently £1,073,100 for 2021/2022.

The lifetime allowance keeps increasing with inflation and is measured by the consumer price index. In March 2021, the UK Chancellor announced that the lifetime allowance would remain frozen until April 2026.

Therefore you need to consult a pension lifetime allowance advisor in the UK to avoid paying a lot of charges.

If you are saving part of your income on a pension scheme, it is important to track all the savings and ensure you don’t exceed the Lifetime Allowance limit. The LTA is 25% if you take your drawings as income or 55% if you take your pension in a lump sum.

The pension provider can decide to apply the tax charge differently depending on how you take the excess benefits above your lifetime allowance. Are you looking for ways to avoid the lifetime allowance tax charge? These are some of the tips you can apply:

Use your spouse’s pension 

If your pension provider has contacted you in writing that you are almost approaching your LTA, you can opt to save your contributions to your spouse’s pension. Saving your spouse’s pension is one of the many benefits of marriage.

When you save the money in your spouse’s name, the money will be in their name, which will come with some risk. If you divorce, your partner gets to walk away with the benefits.

Use your ISA allowance 

You can use your ISA allowance instead of paying your contributions to your pension. This way, you will still benefit from tax-free investment growth. The difference is that the funds you are saving will not be tested against the pension LTA.  

This strategy is not suitable for those on a defined benefit pension scheme. It is better to remain an active member and pay your lifetime allowance.

Take early retirement 

Another way to avoid the hefty LTA tax charges is to take early retirement from work. If you have a confined benefit pension, you should consider early retirement. Most of the confined pension allows you to take your pension before attaining your normal retirement age.

However, when you take a confined pension, your current income will be used to calculate the value of the pension. If you have a lower income, you will avoid paying a lifetime allowance tax.

If you are a current life member of a confined pension, you should consider opting out or changing your membership. Some pensions allow you to build your benefits on a reduced part, also known as 50:50. 

Withdraw tax-free cash 

If you want to avoid the LTA tax charge, you can withdraw some tax-free cash from your pension scheme. This means you will be leaving some funds in your pension to grow, reducing the potential second LTA charge at the recommended retirement age.

Note that any amount you withdraw from your pension scheme will form part of your estate inheritance tax purposes. The funds are held in your pension out of your estate inheritance tax. 

Withdraw your taxable income 

When you withdraw tax-free cash from your pension, the pension is tested against the LTA. However, there is no lifetime allowance test involved when you are withdrawing taxable income. You should consider withdrawing taxable income to the higher tax rate of 20%. 

The 20% income tax is still way below the 25% LTA tax charge. Your pension will be tested at the age of 75 when you retire. Any growth on your pension will be subjected to the lifetime allowance charges.

Final Thoughts 

Taking some prudent steps is the best you can do if you don’t want to exceed the specific LTA in your country. This will help you avoid the tax surprise when you retire at 75.  

If you want to learn more about escaping paying the LTA tax charge, you can consult your financial advisor for more tips. You must keep checking your pension pool to find out if you are still on the right track or exceeding the lifetime allowance. Your pension provider will notify you in writing if you are almost exceeding the set lifetime allowance limit.