When it comes to your pension, you might assume that the more that you can save into it, the better. But that’s not always the case. Once your pension savings reach a certain level, you may need to take action to avoid risking additional tax charges in retirement.

There is a limit to the amount of money you can build up in pensions over your lifetime without triggering a tax charge when you access your retirement pot. Several scenarios can trigger a Lifetime Allowance test, and lead to a possible tax charge, including taking money out of your pension, transferring your pension overseas or turning 75 without having taken benefits from your pensions or with funds in drawdown.

Your pension is designed to provide you with money in your retirement, which can be in the form of income or lump sums. But there is an upper limit on how much you accrue within your pension or pensions in your lifetime, and if you exceed it, you’ll pay an extra tax charge that can be very expensive.

This upper limit is called the Lifetime Allowance, and it is currently £1,073,100 in the tax year 2021/22 (the UK tax year starts on 6 April each year and ends on 5 April the following year).

The Lifetime Allowance was expected to rise in the 2021/22 tax year, as it did in the previous three tax years. But instead, the Chancellor announced in Budget 2021 it would be frozen until at least 2026. This could mean that more people will face the extra tax charge in the future, as they are more likely to exceed the Lifetime Allowance.

Once you exceed the pension Lifetime Allowance, you will at some point pay an additional tax charge (the earliest of crystallising your benefits, death before age 75 or reaching age 75). The charge will be 25% of the excess funds if they are used to provide an income (annuity purchase, scheme pension or placed in drawdown) or 55% (if taken as a lump sum without being placed in drawdown first).

Obtaining professional financial advice is essential to ensure you have in place a withdrawal strategy to minimise the amount of tax you may have to pay.

If you are currently contributing to a pension that is projected to reach a value of £1,073,100 in the future, one way to avoid the tax charge is to stop contributing. This will help you keep your pension value below the upper limit – although your investments could still continue to grow.

While you may be able to avoid the tax charge if you stop contributing, there are potential downsides. One of the biggest is that you may lose out on matched employer contributions. If, for example, your employer matches 100% of your pension contributions, you may have more to gain by continuing your contributions than you’ll lose later in tax charges of up to 55%.

To avoid the Lifetime Allowance tax charge without losing out on your employer contributions, you could discuss your options with your employer. They may be able to offer you additional salary instead of your pension contributions.

Then, you can consider how best to invest this money if not in a pension. There are alternative options, and the best one for you will depend on your other current financial arrangements.

If you have been a member of a registered pension scheme since 6 April 2016 you may be eligible for protection that gives you a higher Lifetime Allowance limit. There are two types of protection schemes available: these are known as Fixed Protection 2016 and Individual Protection 2016.

This gives you a Lifetime Allowance equal to the value of your benefits on 5 April 2016 (but capped at £1.25m). Pension funding can continue but only the pension value at 5 April 2016 is protected from the Lifetime Allowance charge. Both Individual Protection 2016 and Fixed Protection 2016 can be applied for if eligible.

Retirement means different things to different people. Financial freedom allows you to choose the path you want to pursue. Whatever retirement looks like for you, it’s important to review your situation and make plans now so that you have the freedom to enjoy the time when it comes. Please speak to us to discuss your retirement – we look forward to hearing from you.