The start of the new tax year on 6 April brings with it an important change for pension savers – the abolition of the lifetime allowance. 

The lifetime allowance was a limit on the amount you could build up in pension savings without triggering a tax charge. When it still existed, it was set at £1,073,100. 

While the lifetime allowance abolition only benefits a small proportion of the population – as very few of us can hope to become pension millionaires – it makes sense to get to grips with the changes and understand what they might mean for you.

What has changed?

In the past, if you built up more than £1,073,100 in pension savings, you’d have to pay a tax charge when you accessed pension benefits in excess of this amount. If you took benefits as a lump sum, you’d pay tax at 55% on the excess. If you took benefits as income, the rate was 25% and this was charged on top of regular income tax.

A year ago, this tax charge was removed. This meant that pension savers could exceed the lifetime allowance without being penalised and only pay their normal rate of income tax on the excess. Now, the lifetime allowance is being completely abolished.

This doesn’t mean you can enjoy a bigger tax-free lump sum. Previously, you could take up to 25% of your pension as tax-free cash, but this has been capped at £268,275 across all your pensions. So even if you build up, say, £2 million in pension savings, you’ll typically only be able to take £268,275 as tax-free cash, not £500,000. 

Bear in mind that if you have lifetime allowance protections in place or a ‘transitional certificate’, you might be able to receive a bigger tax-free lump sum. It’s possible to apply for certain protections and certificates, but it’s a complex area. It’s always worth speaking to a financial adviser about what’s available and right for you.

Should I save more in pensions?

The abolition of the lifetime allowance makes pensions an even more attractive way of saving for retirement because you no longer need to worry about your pension becoming ‘too big’ (although there are still limits on how much you can contribute, which we’ll come on to shortly).

That means you can make the most of the perks that come with pension saving – in particular, the tax relief you get on contributions. For every £80 you save into a pension, the government adds £20. If you’re a higher or additional-rate taxpayer, you can claim back an additional £20 or £25, respectively, via your self-assessment tax return. Tax relief can help to supercharge your retirement savings, as we demonstrate in this earlier article.

Another advantage of pensions is they can usually be passed on free from inheritance tax (IHT) when you die. So, by saving more money in pensions, you could potentially leave a more tax-efficient legacy for your loved ones. IHT and estate planning is complex, so you may wish to discuss your options with a financial adviser.

What else do I need to consider?

Although the lifetime allowance is being abolished, there’s still a limit on the amount you can save into pensions each year without paying a tax charge. This is known as the ‘annual allowance’ and it is currently £60,000¹. You can only get tax relief on pension contributions worth up to 100% of your gross relevant earnings², capped at £60,000. So, if you earn £30,000 in a given tax year, you’ll receive tax relief on contributions up to that amount. 

It’s important to bear in mind that any money you save into a pension will be locked away until you’re at least age 55 (this will rise to age 57 from April 2028). Before you make a pension contribution, you need to feel confident that you won’t need access to the money before then. 

If you want to invest but think you might need the money a little earlier, an individual savings account (ISA) could be a better option. You can withdraw money from ISAs whenever you like, although any investment should be considered a long-term commitment – at least five years and ideally longer.

The other advantage of ISAs is that while you don’t get tax relief on contributions, withdrawals are completely tax free. With a pension, withdrawals over and above your tax-free lump sum will be taxed at your usual income tax rate. Investing in ISAs as well as pensions may enable you to fund your retirement more tax efficiently, while offering a bit more flexibility when accessing your money. 

Finally, it’s always worth remembering that the rules around pensions and tax can change. The Labour Party has pledged to reinstate the lifetime allowance if it gains power in the next general election, so if you’re approaching retirement we’d suggest getting financial advice in the meantime.

¹ Your annual allowance might be lower than this if you have a very high income. To work out if you have a reduced (tapered) annual allowance, see HMRC’s website or speak to a financial adviser.

² For more on what counts as ‘relevant earnings’ that can earn tax relief when used to fund a pension, see the HMRC Pensions Tax Manual.