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UK Pensions and the Lifetime Allowance (LTA)

British people risk up to 55% taxation if pension funds go over the UK lifetime allowance (LTA), but expatriates can take steps to limit exposure.

Are your UK pension funds safe from lifetime allowance (LTA) penalties? If you have several pensions, have been saving for many years or have a generous company pension, you could be in the firing line for 25% or 55% tax without realising it.

What is the lifetime allowance?

Since 2006, the UK government has capped how much you can hold in combined pension benefits without paying extra tax. Originally £1.5 million, the LTA peaked in 2011 at £1.8 million before gradually dropping to £1 million by 2016. Tracking inflation since then, in April 2019 it lifted slightly to £1.055 million.

Who is affected by the lifetime allowance?

While the lifetime allowance limit sounds high, it does not just capture the ultra-wealthy.

All UK pension benefits outside the State Pension are counted, including everything accumulated over a working lifetime. After decades of pension contributions, compounding interest, investment growth and tax relief, the limit may be closer than you think.

For ‘final salary’ (defined benefit) pension schemes, the usual measure of value is 20x the annual income due. Generally this will mean those with pensions worth £52,750+ a year would be affected today.

In any case, it is a good idea to review your situation, even if you have already started drawing benefits. With appropriate action now, you could protect your retirement savings from unnecessary taxation.

What are the lifetime allowance penalties?

Once total pension funds exceed the allowance limit, extra tax is payable whenever you access your money – technically called a ‘benefit crystallisation event’. How much you pay depends on the way funds are withdrawn – rates are 55% for lump sums and 25% for income or transfers to an overseas pension. So at best, the cost of being over can be a quarter of your funds, at worst: over half.

Being non-UK resident offers no protection. Usually, under the double tax agreement, residents of countries like Portugal, Spain, France and Cyprus are not liable for UK taxes on British pensions (except government service pensions). However, for anyone over the allowance, these rules do not apply – the LTA tax is applied in the UK first and cannot be claimed back.

How can you check your LTA position?

Calculating how much of your allowance you have used is not always straightforward, especially for final salary pensions, so you should check your position with your provider or pension adviser.

HM Revenue & Customs (HMRC) will first test your allowance status when you start drawing your pension, then every time you access funds and when you turn 75. If you die before age 75, any lump sums paid to your beneficiaries will also be subject to the LTA test and subsequent tax penalties.

Each withdrawal uses up a percentage rather than a cash value of your LTA, so once you take 100% there is no remaining entitlement, even if the allowance subsequently increases.

How can you protect your pensions from the lifetime allowance?

You could secure a higher limit by applying for LTA ‘protection’ from HMRC, but this usually has strict conditions attached, so take guidance first.

Expatriates have the option of transferring UK pension funds to a Qualifying Recognised Overseas Pension Scheme (QROPS). As well as limiting your exposure to LTA penalties, a QROPS can provide tax-efficiency, currency flexibility and estate planning advantages.

If you transfer one or more UK pensions into a QROPS and your total benefits are under £1.055 million, you will not face LTA taxes on the transfer. However, make sure the QROPS is within the European Economic Area (EEA), such as Malta, otherwise you would still lose 25% through the UK’s ‘overseas transfer charge’.

Once in a QROPS, funds are out of reach of LTA penalties, no matter how much you have in total or how you access it.

Another option is to take your UK pension as cash and reinvest into a tax-efficient, compliant arrangement in your country of residence.

What if you are already over the LTA limit?

While you would trigger an immediate 25% LTA charge on a QROPS transfer, the funds become immune to further penalties. If you instead transferred to a UK scheme, like a Self-Invested Personal Pension (SIPP), you could do so tax-free but funds would remain liable whenever you take benefits and pass it on to heirs.

If you are hovering under the threshold, consider acting sooner rather than later to prevent growth tipping you over the limit and increasing your liabilities. As the LTA is only set to increase in line with inflation each April, there will not be much leeway if you are already at the upper end.

Regardless of whether the lifetime allowance will affect you, with Brexit around the corner, now is a good time to review your pension options. If you are living in Spain, France, Portugal, Cyprus, Malta or anywhere else, you should regularly check your financial planning to make sure you take advantage of available opportunities and protect your wealth in the most suitable way for your particular circumstances.

UK Expat Pension Reviews specializes in Pension Transfers, UK expat pensions, Expat Life Insurance, Expat Mortgage Finance and Expat Savings and Investments. We offer comprehensive services tailored to the needs of expatriates. Our dedicated team provides expert guidance and assistance in evaluating and optimizing pension portfolios for UK expats worldwide. Whether you're looking to transfer your pension or seeking advice on maximizing your retirement savings, UK Expat Pension Reviews is committed to delivering personalized solutions and ensuring financial security for our clients.