Most people won't pay any tax on their pension until they have retired, at which point regular income tax is applied. The government have, however, set allowances for the amount which your pension can increase by in both a year and in your lifetime before you must pay tax as you earn it. Please follow the links below for more information on these allowances and their tax consequences.
The Government has placed a restriction on the amount of pension individuals may earn each year before they suffer additional income tax liability. For the purpose of calculating Annual Allowance, each year is referred to as a Pension Input Period (PIP). From 6th April 2016 onwards all schemes' PIPs have been aligned to tax years, i.e. from 6th April to 5th April. For each year or PIP, the maximum growth is restricted to a capital monetary value of £40,000. This value is calculated by multiplying the increase in pension over the twelve month period by a factor of 16 then adding the increase in any lump sum entitlement.
Value of benefits as at 5th April 2017
Pension of £8,000 plus lump sum of £20,000
Monetary value of £128,000 (£8,000 X 16) plus £20,000 = £148,000
Value of benefits as at 5th April 2018
Pension of £9,000 plus lump sum of £23,000
Monetary value of £144,000 (£9,000 X 16) plus £23,000 = £167,000
Consumer Prices Index at 2%
Annual allowance figure
Value as at 5th April 2018 = £167,000
Revalued 5th April 2017 value (148,000 x 2%) = £150,960
Annual Allowance figure = £16,040
Any Additional Voluntary Contributions, buying of additional service or additional pension must also be included towards this Allowance.
The Summer 2015 Budget announcement confirmed a number of changes to the Annual Allowance, specifically aimed at "higher earners", by reducing the amount of tax relief they can receive on their pension contributions. These changes came into effect from April 2016.
The Annual Allowance will be reduced from the current £40,000 per annum if both of the following criteria apply:
- Your net income is over £200,000; and
- Your net income plus the value of your pension growth over the tax year is over £240,000
If your Annual Allowance exceeds the limit in any year then you are able to bring forward any unused allowance from the previous 3 years. If this still results in an excess amount then this excess amount must be declared on your annual self assessment income tax return and is added to your other taxable income and taxed at your marginal income tax rate.
Where the amount of tax payable exceeds £2000 an individual has the option to request the LGPS to pay the cost and have a subsequent reduction applied to their pension benefits.
HM Revenue and Customs have an online calculator which allows you to check if you have an annual allowance tax charge on your pension savings.
The Lifetime Allowance, currently standing at £1,073,100, is:
the total amount of pension savings that can be provided to an individual without incurring an extra tax charge.
Any benefits more than the lifetime allowance will become subject to a tax charge.
To calculate the amount of Lifetime Allowance for benefits you have earned in the Local Government Pension Scheme (LGPS):
you take the value of the pension and multiply it by a factor of 20.
Any lump sum benefits are taken into account at their cash value.
Any Additional Voluntary Contributions must be included towards this Allowance
Any buying of additional service must be included towards this Allowance
Any pension must be included towards this Allowance.
Value of benefits at retirement
Pension of £12,000 plus lump sum of £25,000
Lifetime allowance figure
Monetary value of £240,000 (£12,000 X 20) plus £25,000 = £265,000
This amount is well within the limit of £1,073,100
Where any benefits exceed the Lifetime Allowance then they are subject to an excess tax charge of either 25% or 55% depending upon whether they are taken as cash or additional pension.
There are various protections available to assist any employee who considers that their lifetime allowance is close to or already exceeds the limit of £1,073,100. This is a complex area relating to an individual’s total pension wealth and therefore anyone in this position should consider taking independent financial advice.
The lifetime allowance quick check tool on the LGPS member website, allows an individual to work out if they are likely to exceed the lifetime allowance (LTA).