The million (and a bit) pound pension question

Why £1.073m is still a good yardstick

Even though the LTA is no longer in force, its final threshold still determines the maximum tax-free lump sum most individuals can take from their pension: £268,275. Any pension savings above this level won’t increase your tax-free entitlement – in this case, Income Tax will apply.

It’s also worth remembering that while investment growth within a pension is tax-free when achieved, it doesn’t escape tax altogether. When you eventually draw income from your pension, it’s taxed at your marginal rate. So, the more you build above the £1.073 million mark, the more likely you are to face higher tax rates in retirement.

What does a £1.073 million pension provide?

If we assume someone retires at 60 and aims to draw income up to the basic rate Income Tax threshold (currently £50,270), this is how their pension might look (depending on investment performance): 

This assumes no inflation, partly because tax bands haven’t consistently kept pace with inflation in recent years. If tax thresholds were to rise by 2% annually, a return of around 5.33% would be needed to fully deplete the fund by age 90 whilst taking income up to the basic rate tax threshold.

The tax-efficient sweet spot

Given that UK government bonds are currently yielding around 4%, a well-diversified portfolio should be able to support tax-efficient withdrawals up to the basic rate threshold, and still leave a surplus by age 90.

Predictably, though, there is a catch: for individuals with estates already close to or above the IHT threshold, leaving surplus pension funds on death could trigger double or even triple taxation under the new rules being introduce from April 2027. That’s why many are now choosing to draw more from their pensions, even at higher tax rates, to avoid punitive tax treatment later.

Is more always better?

This brings us back to the idea that £1.073 million might be a sensible target for many. It allows you to take the full tax-free lump sum and should be able to provide a sustainable, tax-efficient income throughout retirement. Beyond this level, and especially if you’re trying to minimise IHT exposure, you’re more likely to face higher-rate tax on withdrawals.

That said, there are still scenarios where contributing beyond this level makes sense. For example, if you’re currently a 45% taxpayer and expect to pay 40% in retirement, there’s still a marginal benefit. But for many, the flexibility of ISAs (ie no age restrictions and the ability to access without Income Tax considerations) becomes more appealing when the tax advantage of pensions narrows to just a few percentage points.

Tax-efficient alternatives?

Some investors will look to Venture Capital Trusts (VCTs) or Enterprise Investment Schemes (EIS) as tax-efficient alternatives to pension contributions. While these can offer attractive tax reliefs and don’t carry deferred taxation like pensions, they come with significantly higher risk. These investments require careful consideration and are not a like-for-like substitute for more mainstream pension or ISA planning.

So while the pension landscape continues to evolve, the old Lifetime Allowance threshold of £1.073 million remains a useful yardstick. It strikes a balance between maximising tax-free benefits and avoiding unnecessary tax exposure in later life. As always, the right strategy will depend on your personal circumstances, but it’s important to be aware of the trade-offs before you make any big decisions.