Do you know the value of your pension? Here’s why it’s important.
If it has reached - or is likely to reach - the lifetime allowance by the time you want to withdraw money from your pension or when you’re 75 if that is earlier - there could be tax charges. That’s because the pension lifetime allowance limits the total amount you can build up for retirement, while retaining full tax benefits.
This applies to the value of all your pensions, except your state pension. If you go over this lifetime allowance, you'll generally pay a tax charge on the excess when you take a lump sum or income from your pension pot, transfer overseas, or reach age 75 with unused pension benefits.
The excess can be paid as a lump sum, subject to a 55% tax charge. Or you can opt to keep the money in your pension pot for income, at a charge of 25%. The best way to keep track of whether you might exceed the lifetime allowance is to regularly review the value of your pensions.
Your pension value is tested automatically when you reach 75, to see if it exceeds the lifetime allowance. You can estimate how the value of your pensions might change over the years and plan accordingly. However, the way your pensions are valued depends on the type of scheme you’re a member of. Defined contribution pensions, which provide you with a retirement income based on yours and your employer’s contributions, are tested based on the overall value of your pension pot.
It’s more complicated for defined benefit schemes, which pay a retirement income based on your salary and how long you’ve worked for your employer.
To calculate the total pension value for lifetime allowances, for these pensions, there’s a formula. Multiply your expected annual pension by 20 and add this figure to the amount of any tax-free, cash lump sum from that pension.
If you reach age 75 with unused pension benefits or have pension funds in drawdown, your pension value will automatically be tested against the lifetime allowance. If the test shows you have pension benefits above the lifetime allowance, you'll have to pay a charge, which we've shown you already.
The same automatic test applies if you die before the age of 75. In this case, your beneficiaries can choose how they wish to draw the pension money. Their choice will determine the rate of the tax charge payable. Your beneficiaries are responsible for paying the charge to HMRC.
Whatever the size of your pension pot, it makes sense to keep track of its value and understand what happens if you exceed it. If you’re not sure, then it may be wise to seek advice. If you’re nearing 55 or over, Fidelity’s retirement advisers may be able to help. The Government’s Pension Wise service offers free, impartial guidance to help you understand your options at retirement. Or you can seek the help of an independent financial adviser.
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