One of the most important elements of your overall financial planning is making provision for your retirement. We are all living longer and we are all being encouraged to save as much as possible to ensure a comfortable lifestyle in our (possibly) extended retirement years. However, there is a catch that many people know of, but do not fully understand – the pensions Lifetime Allowance (LTA).
The LTA is a ceiling for an individual’s combined pension benefits that limits the amount you can build up in pensions over your lifetime without potentially triggering a tax charge when you access your retirement pot.
At its peak, the LTA stood at £1,800,000 but is currently £1,073,100 and now frozen for 5 years. The LTA is no longer just the preserve of the very wealthy, so what can you do about it?
How the LTA works
It is important to understand how the LTA works before assessing whether it impacts you. If the value of your pension plan(s) exceeds the LTA, then you do not immediately have an LTA charge to pay. It is only when you trigger what is known as a Benefit Crystallisation Event (BCE) that you may create a charge. There are a number of official ‘Events’ which range from:
– Drawing benefits (such as taking tax free cash)
– Reaching age 75
– Death
There are other factors to consider too, such as assessing what type of pension plan you have. Perhaps you have a Final Salary (Defined Benefit) scheme which will only have one BCE; or a personal/flexible pension (Defined Contribution) which may see a number of BCEs over the course of your life.
The latter of these pensions, as the name suggests, means you will have flexibility on how and when you can draw benefits from your retirement provisions, and this is where the majority of LTA planning can be undertaken.
In reality, every individual with a private pension will reach a crystallisation point in their lifetime, so it is important to review everything if you feel that you may, at some point in the future, exceed the LTA.
You may also be eligible to protect a higher LTA from previous years. Over the past 10 years, the LTA has reduced from £1.8m, in stages, to where it currently is today. At those particular stages, various levels of protection were available to individuals lucky enough to have pensions that exceeded the new LTA at that time. You may still be eligible to benefit from some of these protection points, and this is something worth looking into further.
Navigating the LTA charges
If you crystallise a pension that creates an LTA charge, then you have two options with different charges attached.
1) Withdraw the excess pension over the LTA as a lump sum. This will trigger a 55% tax charge, based on that excess figure
2) Leave the excess in the pension or draw it out as income. The LTA charge is reduced to 25% on the excess, however, you will also pay income tax on any future withdrawals, at your marginal rate
What should I do next?
If you think your pension funds will exceed the LTA, you need to decide what strategy to adopt. Simply accepting the position, without an applied view can prove very costly indeed.
Income tax, LTA charges and Inheritance tax (IHT) are all areas that can be mitigated by careful planning. In terms of estate planning for example, pensions do not form part of your estate that is considered for IHT on death. As a result, some individuals will leave their pensions (or the element of their pension which exceeds the LTA) to grow without ever touching them, spending their other assets instead and allowing more to pass tax efficiently to the family. There is an LTA charge to consider at age 75 – however, an LTA charge of 25% is lower than IHT, currently 40%.
Others will be better served by taking tax free cash, and managing their LTA position up until the second test at age 75. Perhaps it is a combination of the two. It depends on how you envisage using your pension.
Understanding your pensions can be a complicated process and especially so for those with LTA considerations. At Kellands, we are passionate advocates of the benefits of independent financial advice. If you are impacted by the LTA, it is vital to have a professional view on your specific options, and to have a strategy to best manage the position for you and your family.
Ian Boasman, Chartered Financial Planner
