Pension Lifetime Allowance
Folks who are fortunate enough to be able to contribute a significant amount to the pension seem to worry an inordinate amount about the Pensions Lifetime Allowance (LTA). Common advice seems to be to avoid putting money into the pension above the LTA - and the name "Lifetime Allowance" definitely doesn't help here - it almost sounds as if it was a hard limit one must not exceed - or maybe that's just me.
To be honest, I'm not sure whether I'll reach the Lifetime Allowance or not. Just in case, though, I decided it'd be worth figuring out whether I should keep contributing to the pension if I ever reached it.
LTA Calculator
Lo and behold, here's a little calculator that shows whether you'd still be better off contributing above the LTA, or whether you'd be better off putting the money into an ISA or similar. As for the settings:
- Tax rate during accumulation - This is your tax rate whilst you are contributing to the pension. Since pension contributions are effectively on gross income, a higher tax rate makes for a more tax efficient pension contribution.
- Employer contribution - This is the amount your employer contributes to the pension (including NI saving), as a percentage of the total contribution. For example, if you contributed 7% of your salary every month to the pension, and your employer contributed another 3%, you'd use 30% in this field - as the employer contributes 30% of the total (10% of the salary).
- Withdrawal amount - This is the amount you'd expect to take out of your pension any given year during retirement. The first 25% is tax-free, and you pay income tax on the rest - so the amount matters. Withdrawing more means you pay more taxes, potentially tipping the balance away from further pension contributions.
- Other income - This is any other income you expect to receive during retirement - for example the state pension. It matters insofar it increases your total income for the year, and so you'd end up paying more taxes on the income that you draw from the private pension.
NOTE: The calculator updates the result immediately, as soon as any of the inputs changes.
Basic rate tax payer
Below is a table with a few examples if you are a basic rate tax payer (20% band) when you are contributing to the pension. Without any employer contributions, you'd indeed be better off not exceeding the lifetime allowance, and instead topping up other accounts, such as ISAs. The picture changes quickly if the employer contributes a part to the pension, though.
At a 20% contribution (e.g. you contribute 16% of the salary and the employer contributes 4%), you'd already be better off in many cases, unless you have other income, such as state pension, that ends up eating into your personal allowance in retirement.
From 25% employer contribution onwards (e.g. you contribute 15% and the employer contributes 5% of your salary), you are better off in a majority of cases by paying into the pension even above the lifetime allowance.
Higher rate tax payer
The next table shows how it all looks if you are a higher-rate tax payer (40% band). Here things are dramatically different - there's pretty much no case where you'd be worse off contributing to a pension even above the lifetime allowance - even without any employer contribution. Add even a small employer contribution, and it's a no-brainer.
Additional rate tax payer
As an additional rate tax payer, I'd really struggle to see why you'd ever reduce your pension contributions to stay under the LTA. It's hard to think of a practical case where you could do any better than contributing the maximum to the pension.
The End
And that's it! Turns out, the pension lifetime allowance isn't as terrible as it looks (or sounds). Contributing to a pension above the LTA almost always makes sense for higher and additional rate tax payers. For basic rate tax payers, as long as the employer contributes at least a 20-25% of the total, it also all works out. So unless you are a basic-rate tax payer with no employer contribution, the LTA doesn't seem too bad.