Nine ways to counter the lifetime allowance freeze

With the government freezing the lifetime allowance (LTA) until April 2026, more clients could be caught by an LTA charge as the next few years roll by.

After calculating which clients are at risk of exceeding the limit, what options are there to counter the freeze?

1. Explore an ISA

If clients are running out of allowances for their pension, re-directing contributions into an ISA could be a tax-efficient alternative. Adopting this approach isn’t generally recommended for those in defined benefit (DB) schemes because, in most cases, they will be better off continuing to accrue benefits within those schemes.

2. Consider an investment account

If clients have used up their ISA allowances, they can contribute to an investment account, which typically offers the same choice of investments as an ISA. An investment account can be less tax effective than an ISA, but has no limit on the amount invested (except that set by the product provider).

3. Carry on saving for a pension

It may be advisable for clients to keep saving into a pension rather than stopping contributions to avoid a charge, particularly if an employer is contributing too. Forfeiting employer contributions may leave clients worse off financially than paying tax on any LTA excess.

4. Take the tax-free cash under a DC scheme with residual fund in drawdown

For those over the minimum retirement age, one of the simplest ways to reduce the risk of exceeding the LTA is for clients to withdraw the tax-free cash, so leaving fewer funds in their pension (i.e. in drawdown) to potentially grow.

However, they do need to think about the second LTA test at age 75 or earlier annuity purchase along with, of course, their wider estate planning objectives.

Growth on the remaining drawdown fund can also be mitigated by taking income withdrawals, although these will be subject to income tax at the client’s highest marginal rates.

5. Take the maximum tax-free cash entitlement under a DB scheme

It may be possible for clients in DB schemes to take more tax-free cash than they were expecting (up to a limit) in exchange for an even lower pension entitlement.

Doing so often reduces the overall value of the benefits to be tested against the LTA, unless the commutation factor is high (e.g. over 20).

6. Re-direct contributions to a partner

Clients can re-direct contributions into a spouse’s or civil partner’s pension (subject to their own tax relief, annual allowance and lifetime allowance limits), helping reduce the risk of exceeding the LTA. Contributions can be made to your Children's pensions, too.

7. Think about retiring early under a DB scheme

For some clients in DB schemes, retiring early and taking an actuarially-reduced pension – if offered by their employer – could potentially reduce the value of their benefits to below the LTA.

8. Wait to take your pension or pass it on

For clients with other sources of income, or those considering passing on their pension fund on death, they could delay taking any benefits. This is because, with one exception relating to a DB scheme pension, the LTA does not apply after the age of 75. So, if the value of their pension benefits is below the LTA at this point, and they haven’t drawn on it, they can keep it invested and let it continue to potentially grow as the pension will not be tested again.

9. Apply for fixed protection 2016 or individual protection 2016

Provided clients have not made any contributions since 5 April 2016, Fixed Protection 2016 boosts their LTA to £1.25m. Similarly, clients may be eligible for Individual Protection 2016 provided all their pensions combined came to at least £1m on 5 April 2016. This gives a personalised LTA equal to the value of their pension on that date, up to £1.25m, as well as allowing for pension savings to continue if necessary.

Important information

This article is based on current understandings of tax rules and may change in the future.

About the author

Scott Sinclair, Content Strategy, Embark Group

Scott Sinclair is a former financial journalist and editor who has spent the past five years creating engaging content for financial advisers, first with Zurich and then Embark Group. Scott was editor of Professional Adviser, part of Incisive Business Media, between 2012 and 2016.

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