The lifetime allowance tax was introduced in 2006 at a level of £1.5 million. It then increased each year to 2010,when it reached a level of £1.8 million. Since 2010, there have been a number of pension reforms which have led to the lifetime allowance being reduced. Its current level in the 2016-17 tax year is £1m having been reduced from £1.25 million.
This may sound like a high figure but we are finding clients with estimated benefits of c.£30,000 are straying into this super tax with the dramatic increase in transfer values being offered by schemes. In 2006 a little over 120million left final salary schemes moving into private arrangements. In 2016 there was over £1.5billion!
This is a huge indication that more members are coming to the conclusion that not all schemes are fit for purpose. This coupled with UK pension deficits rising above £900billion post BREXIT and with the pension freedom act of 2015 allowing members to take control of their pension funds is far more appealing to most. Flexible draw down and the choice of wealth over income is becoming the preferred path for many.
I explained in a previous article the basics of LTA, in this article I will run over the LTA charges and protection members can apply for with HMRC.
Lifetime Allowance Charge
Although it is possible to accrue benefits of any size in a UK registered pension scheme, the lifetime allowance (LTA) caps the benefits that can be taken without a tax charge (the LTA tax charge) above income tax.
The LTA is currently £1.25million in 2015, but is due to be reduced to £1 million in April 2016. The LTA tax charge only applies when ‘Benefit Crystallisation Events’ (BCE) occur. There are currently 13 triggers to a BCE. However the most common are when a person buys an annuity, draws a tax free lump sum, puts their pension fund into “drawdown” or reaches age 75.
Dodging the bullet…until age 75
There is no requirement to ever actually draw your pension benefits, however they will be tested against the LTA when you turn age 75. This means it is not possible to completely avoid an LTA test just by deferring pension benefits. You do not need to draw all your pension benefits in one go. Instead, you can part crystallise a pension and delay the LTA tax charge until a further BCE occurs. Thus aiding the overall investment growth potential, as the funds would remain untaxed in the pension.
So how much will need to be paid?
When a BCE occurs that does incur an LTA tax charge, you have two options: Lump Sum You can take the excess as a lump sum and pay a one off 55% tax charge. Income you can leave the excess within the pension and pay a one-off 25% tax charge. Any withdrawals will be charged at your highest marginal rate of tax. Deciding which option best suits you depends on whether you plan to leave the pension as an inheritance, or plan to draw on the funds in the future. It is possible plan for this event and draw down any investment growth each year in order to pay tax at your highest marginal rate rather than incur the 55% tax charge at 75. However, this should be considered as part of a wider income strategy long before the event occurs.
Managing the lifetime allowance and your pension’s exposure to tax takes an in-depth knowledge of legislation and tax rules both in regards to pensions and income.
The government has an understanding that it would not be fair to backdate the new LTA to members who have already built pension values in excess of the new proposed limit. Therefor they offer savers two types of protection.
Individual protection will allow you to protect the value of your pension before the lifetime allowance is reduced. It is designed to enable people with pension funds exceeding the new LTA not to be automatically taxed in accordance with the new limit. To use an example, a member with pension savings worth £1.1m on 5 April 2016 can lock-in a personal LTA of £1.1m as this is still be inside the current limit. In contrast, someone with savings worth £1.4m would only secure a £1.25m allowance or the value up to the current LTA. It’s important to note that you can’t protect funds in excess of the current or in some cases previous LTA. The protection will remain available until April 2019.
Fixed protection will allow you to lock in the current LTA for your pension however no further contributions can be made. Growth can still be achieved over and above this. As an example, someone who has pension savings of £1.1m and is happy to make no further contributions until they retire can apply fixed protection to the pension and this will allow the investment growth of the pension to grow to the previous limit of £1.25m even after the LTA has been lowered. This protection will allow members to protect the previous LTA of £1.25 million and can be applied retrospectively from 2016. Protecting your lifetime allowance is essential and can result in saving of hundreds of thousands of pounds in some cases.
PS&Partners operates an open information policy. This means that we are happy to talk through the various options with you without charge and on a no obligation basis either over the phone or face to face. So get in touch and see if we can help, here’s a few things to consider before getting in touch:
You may be surprised by the current value of your pension get a free valuation from our UK office.
You may have already moved a pension but the adviser did not fix any protection for you.
You may have no idea what your pension is worth.
If you no longer have a spouse where do the benefits go upon death?
Perhaps 60/65 is too long to wait for benefits and the early drawdown penalties are too high to consider.
Please contact your PS & Partners Advisor at www.partners-ps.com for more information regarding the LTA and the effects it could have on your and your beneficiaries.