It applies to the total of all the pensions you have, including the value of pensions promised through any defined benefit schemes you belong to, but excluding your State Pension.
From 6 April 2018, the standard pension lifetime allowance now increases annually in line with the Consumer Prices Index (CPI).
Charges if you exceed the lifetime allowance
It’s important to think about what the value of your pension savings could be in the future. If the cumulative value of the payouts from your pension pots – including the value of the payouts from any defined benefit schemes – exceeds the pension lifetime allowance, there will be tax on the excess (called the ‘lifetime allowance charge’).
The way the charge applies depends on whether you receive the money from your pension as a lump sum or as part of regular retirement income.
Any amount over your lifetime allowance that you take as a lump sum is taxed at 55%. Your pension scheme administrator should deduct the tax and pay it over to HM Revenue & Customs (HMRC), paying the balance to you.
Any amount over your lifetime allowance that you take as a regular retirement income – for instance, by buying an annuity – attracts a lifetime allowance charge of 25%. This is on top of any tax payable on the income in the usual way.
For defined contribution pension schemes, your pension scheme administrator should pay the 25% tax to HMRC out of your pension pot, leaving you with the remaining 75% to use towards your retirement income.
For example, suppose someone who pays tax at the higher rate had expected to get £1,000 a year as income, but the 25% lifetime allowance charge reduced this to £750 a year. After Income Tax at 40%, the person would be left with £450 a year.
This means the lifetime allowance charge and Income Tax combined have reduced the income by 55% – the same as the lifetime allowance charge had the benefits been taken as a lump sum instead of income.
For defined benefit pension schemes, your pension scheme might decide to pay the tax on your behalf and recover it from you by reducing your pension.
If you wish to avoid the lifetime allowance charge, it’s important to monitor the value of your pensions, and especially the value of changes to any defined benefit pensions, as these can be surprisingly large.
You might also wish to consider applying for protection if your pension savings are expected to exceed the lifetime allowance threshold.