What is The Lifetime Allowance?
Since its peak of £1.8m in the 2011/12 tax year and three subsequent reductions since then to its current £1m level, the Pension Lifetime Allowance (The Lifetime Allowance (LTA) is a limit on the amount of pension benefit that can be drawn from pension schemes – whether lump sums or retirement income – and can be paid without triggering an extra tax charge.) is becoming more of a challenge and issue for an increasing number of members.
Further exacerbated by increased transfer values from Defined Benefit (Final Salary) schemes owing to economic conditions, and more members taking these transfers to access freedoms via a SIPP.
The tax charges for any monies exceeding the LTA, remembering that you can usually take up to 25% of the LTA as Pension Commencement Lump Sum (PCLS) with the rest giving an entitlement to income, are relatively simple. You pay a 55% LTA charge in a lump sum, or 25% (In addition to your marginal rate of income tax) if you elect to take this as income.
So, for a nil rate tax payer on extraction (which may not be likely given there is a LTA excess) they would get 75% of any excess that is designated for paying income. Basic, higher and additional rate taxpayers would get 60%, 45% and 41.25% respectively. The lump sum being a one-off payment means that irrespective of marginal tax rates the member gets 45% of the excess.
What can you do?
In most circumstances, the pension funds are going to face a LTA test at some point. If you have funds above the LTA (£1M) you can defer any charges by drawing up to 100% of the LTA and leaving the remaining funds untouched. But at age 75 there will be a test on undrawn funds.
Two possible planning options:
1. If you use 100% of the LTA (£1M), take £250k of Tax-Free cash and place £750k into income drawdown there’s no immediate LTA charge. If the drawdown pot has grown to £1m at age 75 then £250k will be over the LTA (£1m less £750k). As the fund is already designated to provide an income, the 25% LTA charge applied and £62,500 is payable. But at age 75 it’s only the growth of a pension drawdown pot that is tested against the LTA.
What does that mean?
The crucial thing with this test is that if you take income from the drawdown pension, it’s not added back into the LTA calculation. It’s simply the value of what’s in the plan that matters. So, if you take the growth out as income then you can avoid the LTA charge. However, the income that has been taken will be taxable on the client, and if they have an IHT issue and this money stays in the estate then the beneficiaries may be worse off.
2. Another quirk that can work is that crystallised funds (taking the maximum possible tax-free cash) aren’t tested again against the LTA if death is before 75. So, if you have a shorter life expectancy (death pre-75) you may want to pay the excess LTA charge sooner rather than later and leave the fund to grow. If you die before 75 then the remaining drawdown pot will usually pass on tax free to your beneficiaries.
What’s your strategy?
If you have any questions around planning for the Lifetime Allowance please do get in touch. You can call us on 01825 76 33 66 or complete a contact form.