Do we know how much will the lifetime allowance increase by next year? Am I right in thinking it goes up in line with inflation every year?

Derek

Tom Selby
AJ Bell Senior Analyst says:

The lifetime allowance is the cap on the amount you can build up in a pension over the course of your lifetime before it imposes tax charges to penalise you for the growth of the fund.

Each time you trigger a ‘benefit crystallisation event’, you will use up a proportion of your available lifetime allowance.

There are a number of benefit crystallisation events that can occur in someone’s lifetime, including taking your 25% tax-free cash, entering drawdown or reaching age 75.

You can read more about benefit crystallisation events and the lifetime allowance in general here. 

For years the lifetime allowance was subject to regular cuts, from a high of £1.8 million in 2011/12 to £1 million in 2017/18. Since then it has been pegged to Consumer Prices Index (CPI) inflation and currently stands at £1,073,100.

The Government has previously used the CPI figure from September to determine the following year’s lifetime allowance, implying next year it will rise by 0.5%.

However, to complicate things further the Government has used slightly different calculations each year to determine the lifetime allowance figure.

For the current tax year (2020/21) it used the increase in CPI to 3 decimal places in September 2019 to determine the lifetime allowance (there are documents hidden away on the Office for National Statistics website which show the value of CPI to 3 decimal places). This figure was then rounded up to the nearest £100.

Assuming the same methodology is used for the next tax year (2021/22) the lifetime allowance should increase by £5,800 to £1,078,900, allowing most people to generate an additional £1,450 in tax-free cash.

WHAT ARE THE ALTERNATIVES FOR PEOPLE AT RISK OF BREACHING THE LIFETIME ALLOWANCE?

While a lifetime allowance of over £1 million might sound like a king’s ransom, for a healthy 65-year-old who took their maximum tax-free cash entitlement it would buy a single-life annuity paying less than £28,000 (assuming full tax-free cash entitlement is taken) – a decent income but below the average salary in the UK.

If paying more into your pension would put you at risk of breaching the lifetime limit – and remember that any investment growth you enjoy could also see you hit with a lifetime allowance charge – you could consider topping up your ISA contributions instead.

ISAs benefit from an annual allowance of £20,000, offer tax-free investment growth and can be accessed tax-free whenever you want.

There are also other vehicles, such as Enterprise Investment Schemes and Venture Capital Trusts, which offer tax benefits, although the investments available through such schemes tend to be higher risk.

DO YOU HAVE A QUESTION ON RETIREMENT ISSUES?

Send an email to editorial@sharesmagazine.co.uk with the words ‘Retirement question’ in the subject line. We’ll do our best to respond in a future edition of Shares.

Please note, we only provide information and we do not provide financial advice. If you’re unsure please consult a suitably qualified financial adviser. We cannot comment on individual investment portfolios.

‹ Previous2020-10-29Next ›