For many the lifetime allowance (LTA) on the value of your pension savings will become an increasing concern as the tax net is reaching wider with many more people paying tax on their pension savings then ever before.
Awareness of the lifetime allowance and the implications for pension savers is now a key part of financial planning for many. So, what can be done to plan effectively in this area?
Recap of the Lifetime Allowance
Let’s start with a quick recap of the lifetime allowance framework.
The lifetime allowance was introduced in 2006 at £1.5m, peaking at £1.8m in 2012 and then reducing in stages to a low of £1m in 2016.
It currently stands at £1.055m for the 2019/20 tax year and will increase with inflation going forward (unless the rules change again).
However, it was possible to protect pension savings above the lifetime allowance in certain circumstances under various statutory protections that were introduced as part of the original pension legislation.
A check of available LTA is only made when pension benefits are drawn (known as crystallised). Every time further pension benefits are crystallised, a percentage of the lifetime allowance is used. The LTA tax charge will only start to apply when there’s no longer any LTA left to cover the amount being crystallised — in other words, when 100% has been used up. This means that the LTA charge can be deferred until as late as age 75 even where you start to draw benefits sooner.
How much is the LTA Tax Charge?
The LTA tax charge is 55% if excess funds over the LTA are taken as a lump sum (or series of lump sums). Where the excess funds over the LTA are taken as regular contributions, the tax charge is 25% tax. It is not possible to draw tax free cash from excess funds over the lifetime allowance.
In addition, when income is taken from the pension pot it’s normally taxed as income. However, the overall effective rate will normally be much less than the headline 55% rate for lump sums.
Options
There are many points to consider. Here are just a few:
- Drawing a regular amount rather than a lump sum – Of the 4,500 people paying LTA tax charge in 2017/18 — two thirds of them paid 55% tax. However, there was another option – the income option is just 25% (plus income tax), so a point to consider here is whether a lump sum was needed at all. Also, did their scheme allow them to draw a regular payment and if not, could a transfer to an alternative pension scheme have reduced their tax charge? A modern flexible defined contribution pension will normally allow all available options, including the drawdown option that comes with a reduced level of LTA tax. If this was managed better one can preserve one’s wealth for longer and there’s more to pass on to beneficiaries rather than the exchequer.
- When should benefits be crystallised to minimise any potential LTA tax charge? Good financial advice can help identify whether crystallisation should occur sooner or later.
- How should pension benefits be drawn? Should these be drawn down fully or phased over many years? Most people will have taken many years of careful planning to accumulate their pension wealth. It’s therefore important not to damage all of the hard work by drawing down pension benefits without the same care.
- When should the tax-free lump sum be drawn? At age 55? At age 75 or at some other time? These questions can be answered by working with a pension professional and analysing one’s objectives, needs and goals and overall financial circumstances.
- When should excess funds above the LTA be drawn and how? As a lump sum at 55% or as income at 25% – does the pension even need to be drawn at all?
- If funds are withdrawn earlier and are surplus to requirements, where could they be invested? What investment structure provides the best outcome?
- What arrangements provide the best legacy for beneficiaries? Ensuring that careful consideration is given to who benefits from the pension(s) and the potential tax consequences for them.
There are therefore lots of possible variables as well as different circumstances that individuals can find themselves in both personally and financially. The unprepared and uninitiated could therefore find they inadvertently pay considerably more tax than was necessary.
It’s very important to discuss these points and the wider picture with a professional Independent Financial Adviser who can help you to consider the bigger picture, place you in an informed position and provide advice on the best way forward. Without doing so risks the potential of doing more harm than good.
A key challenge is that there are many moving parts involved. Pensions legislation is always on the agenda of the government of the day. The LTA planning window is a long term challenge for pension savers, with variables changing every year. Every previous calculation should be reviewed at each subsequent planning review with your adviser.
A key element in financial planning is the ongoing review to ensure the best outcomes, which entails a clear understanding of your needs and goals as well as the legislation applying at the time and the personal circumstances in each case.
A focus just on the LTA and mitigating the potential tax charges along however could cause problems elsewhere.
Conclusion
The Lifetime Allowance is clearly a complex part not just of pensions but within the wider context of financial planning and is to be ignored at your peril. Obtaining Independent Financial Advice concerning these complicated decisions can help to provide a useful perspective and inform the planning strategy going forwards.
For clarification of any points discussed above and any future independent advice regarding your own financial planning, please do contact us on 01626 833225 or email [email protected]
This blog is intended to be for information purposes only and does not constitute financial advice, nor is it is intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investment recommendations. Information herein is believed to be reliable but Loughtons Independent Financial Advisers does not warrant its completeness or accuracy. No responsibility can be accepted for errors of fact or opinion. This does not exclude or restrict any duty or liability that Loughtons Independent Financial Advisers has to its customers under the Financial Services and Markets Act 2000 (as amended from time to time) or any other regulatory system.