Pension lifetime allowance
Discussion
Apologies, I know this is probably an easy question but google is not helping me!
If you are above the pension lifetime allowance there is additional tax to pay if you make a withdrawal (assuming not part of the tax free allowance)
If you were above the lifetime allowance but made a tax free withdrawal to reduce the pension pot to below the lifetime allowance would future withdrawals be subject to the additional higher rate tax hit or would it just be taxed at the normal rates now you are under the lifetime allowance?
Thanks
If you are above the pension lifetime allowance there is additional tax to pay if you make a withdrawal (assuming not part of the tax free allowance)
If you were above the lifetime allowance but made a tax free withdrawal to reduce the pension pot to below the lifetime allowance would future withdrawals be subject to the additional higher rate tax hit or would it just be taxed at the normal rates now you are under the lifetime allowance?
Thanks
If I have understood correctly the way the LTA works is this,
Mr X has a Defined Benefit occupational pension which used up 50% of his LTA of £1m.
When he retired at age 65 he also had a separate SIPP with a pot of £480k which he put into drawdown and this used up a further 48% of his LTA.
He was in the happy position of having used 98% of his LTA and had suffered no additional tax.
However, Mr X also has a substantial ISA and decided to live on tax free money from his ISA rather than drawing a taxed SIPP income.
By age 75 Mr X's drawdown pot has increased through investment returns to £600k - representing 60% of his LTA. 50% + 60% = 110%
At age 75 Mr X will suffer a £25,000 tax charge on his pension pot, i.e. 25% of the £100k excess. [Corrected: see LeoSayer below.]
Mr Y starts out in exactly the same position as Mr X. However, Mr Y is wondering how to use his resources most tax-efficiently.
Mr Y realises that his drawdown pot is likely to increase through investment returns to about £600k by the time he reaches age 75.
Mr Y takes a drawdown income of £10,000 p.a., adding up to £100k by his 75th birthday and leaving a drawdown pot of £500k still invested.
Mr Y's LTA test at age 75 does not result in any tax charge. His DB pension took 50% of LTA and his drawdown pot of £500k is also 50%.
Mr Y is away and laughing, bang on 100%
Note: Mr Y has probably been paying income tax at 40% on his £10k p.a. of drawdown income. Further, Mr X has had 10 years of additional investment growth on the £100k he left invested and that may be easily be enough to cover the additional tax. So things aren't always as clear cut as they look from the headline numbers!
- Whenever you take anything out of your main pot you use up a percentage of your LTA. This includes moving funds "into drawdown" whether or not you actually take out that cash straight away. All of these things are called "crystallisations".
- If you don't keep under your LTA then any crystallisations at a time when you're exceeding your LTA will suffer the enhanced rates of tax.
- It's entirely possible to drop back under your LTA - for instance due to a fall in stock market values reducing the value of your pot(s).
- Through all of this your actual LTA remains protected - you don't suffer additional tax on everything, just on the excess above LTA.
- You may already have everything in drawdown but the check includes the value of your remaining drawdown funds.
- However, AFAIK it doesn't take into account any income you have previously "drawn down".
- So if you draw down enough income before age 75 to ensure you don't exceed your LTA at age 75 you won't suffer any additional tax.
Mr X has a Defined Benefit occupational pension which used up 50% of his LTA of £1m.
When he retired at age 65 he also had a separate SIPP with a pot of £480k which he put into drawdown and this used up a further 48% of his LTA.
He was in the happy position of having used 98% of his LTA and had suffered no additional tax.
However, Mr X also has a substantial ISA and decided to live on tax free money from his ISA rather than drawing a taxed SIPP income.
By age 75 Mr X's drawdown pot has increased through investment returns to £600k - representing 60% of his LTA. 50% + 60% = 110%
At age 75 Mr X will suffer a £25,000 tax charge on his pension pot, i.e. 25% of the £100k excess. [Corrected: see LeoSayer below.]
Mr Y starts out in exactly the same position as Mr X. However, Mr Y is wondering how to use his resources most tax-efficiently.
Mr Y realises that his drawdown pot is likely to increase through investment returns to about £600k by the time he reaches age 75.
Mr Y takes a drawdown income of £10,000 p.a., adding up to £100k by his 75th birthday and leaving a drawdown pot of £500k still invested.
Mr Y's LTA test at age 75 does not result in any tax charge. His DB pension took 50% of LTA and his drawdown pot of £500k is also 50%.
Mr Y is away and laughing, bang on 100%
Note: Mr Y has probably been paying income tax at 40% on his £10k p.a. of drawdown income. Further, Mr X has had 10 years of additional investment growth on the £100k he left invested and that may be easily be enough to cover the additional tax. So things aren't always as clear cut as they look from the headline numbers!
Edited by anonymous-user on Monday 14th December 20:43
rockin said:
At age 75 Mr X will suffer a £55,000 tax charge on his pension pot, i.e. 55% of the £100k excess.
See here: https://techzone.adviserzone.com/anon/public/pensi..."When an individual reaches age 75, any pensions that are still uncrystallised at that point will be tested against their available LTA. If there is insufficient LTA, then the LTA charge of 25% will be levied on the excess (the 55% charge is not an option at age 75)"
Also, I noticed you (intentionally?) didn't mention that the LTA increases with inflation.
Thanks for that, and apologies for my error. The correct approach is that, "When an individual reaches age 75, any pensions that are still uncrystallised at that point will be tested against their available LTA. If there is insufficient LTA, then the LTA charge of 25% will be levied on the excess (the 55% charge is not an option at age 75)."
Before age 75 it's a 55% charge on excess value and +25% (on top of usual income tax) on withdrawals.
I chose the figure of £1m for LTA to keep the attempted examples as simple as possible. Yes, the basic LTA gets some inflationary increases. However, to date anyone who has filed for "protection" at the previously higher LTA levels (for instance £1.8m or £1.2m) gets no such increases.
Before age 75 it's a 55% charge on excess value and +25% (on top of usual income tax) on withdrawals.
I chose the figure of £1m for LTA to keep the attempted examples as simple as possible. Yes, the basic LTA gets some inflationary increases. However, to date anyone who has filed for "protection" at the previously higher LTA levels (for instance £1.8m or £1.2m) gets no such increases.
Of course, to counter some of that pain, the DC pension pot is free of inheritance tax to any beneficiaries should you (heaven forbid!) pop your clogs before 75.....& only subject to the recipient's income tax after that point.....whereas ISA money will be subject to the 40% IHT
It's a bit of a minefield.....but yes, it makes sense to use up the growth in the pot before 75 if you are at the LTA to avoid that causing moderate pain at that age.
It's a bit of a minefield.....but yes, it makes sense to use up the growth in the pot before 75 if you are at the LTA to avoid that causing moderate pain at that age.
LeoSayer said:
Are Mr X and Mr Y expected to complete tax returns to ensure they pay (or don't pay) the correct LTA tax?
Or are the DB and SIPP providers expected to collaborate to ensure the correct tax is paid?
Must say, I wonder about this.....Or are the DB and SIPP providers expected to collaborate to ensure the correct tax is paid?
Pretty sure the TFLS does NOT figure anywhere in a tax return, as such.....
I've taken a couple of TFLS amounts: I do get a certificate for each to say what % of the LTA was impacted, but unless all your pensions are with the same company, I'm not absolutely clear where it stacks up.
Obviously they will know your national insurance number, so perhaps those get passed up invisibly and recorded somewhere!
mikeiow said:
.& only subject to the recipient's income tax after that point.....whereas ISA money will be subject to the 40% IHT
Thanks for that Mike. For clarity, and beyond 75, the balance of the pension pot would "only" be subject to the recipient's "current" rate ? So if he/she is a lower rate taxpayer, he/she would only pay 20% (currently) irrespective of how much they receive out of the pension pot they inherit?nickfrog said:
Thanks for that Mike. For clarity, and beyond 75, the balance of the pension pot would "only" be subject to the recipient's "current" rate ? So if he/she is a lower rate taxpayer, he/she would only pay 20% (currently) irrespective of how much they receive out of the pension pot they inherit?
No, it's taxed as PAYE so progressive rates.chip* said:
rockin said:
Mr Y takes a drawdown income of £10,000 p.a., adding up to £100k by his 75th birthday and leaving a drawdown pot of £500k still invested
Any specific reason as to why you excluded this £100k drawdown income from the LTA? The only additional LTA tax paid by Mr X would be from investment gains above inflation on the £100,000 that he chose to keep invested in the SIPP.
The only realistic way for either to avoid the tax is to retire early or move into less risky assets.
This makes my head hurt.
I'm no guru on this highly complex stuff. I believe that at 75 the LTA check essentially looks at the remaining headroom between what you previously crystallised and your LTA. As such, it doesnt look at what income you've already drawn but does look at the size of the pot you've got left relative to that remaining headroom.
Someone more familiar with the subject may be able to clarify.
Someone more familiar with the subject may be able to clarify.
Also for Mr X, I assume you crystallise his £480k by mean of a FAD, so he can leave the entire £480k invested within his drawdown pot. To my knowledge, you can retain the 75% in your drawdown pot, but the 25% TFC would eventually be paid out (maximum you can defer payment is 12 months), so your growth would only be applicable on the 75%.
As you said, this is a complex topic, and I am glad to have an excellent advisor to keep me informed on a topic which is very close to my heart
/apology for bit reply, but am skim reading this thread whilst keeping 2 toddlers entertained /getting ready for the beach is fairly time consuming!!
As you said, this is a complex topic, and I am glad to have an excellent advisor to keep me informed on a topic which is very close to my heart
/apology for bit reply, but am skim reading this thread whilst keeping 2 toddlers entertained /getting ready for the beach is fairly time consuming!!
rockin said:
I'm no guru on this highly complex stuff. I believe that at 75 the LTA check essentially looks at the remaining headroom between what you previously crystallised and your LTA. As such, it doesnt look at what income you've already drawn but does look at the size of the pot you've got left relative to that remaining headroom.
Someone more familiar with the subject may be able to clarify.
Correct.Someone more familiar with the subject may be able to clarify.
The purpose of the age 75 LTA check is to encourage people to draw potentially taxable pension from their pension scheme rather than leave it in the pension scheme as an IHT avoidance arrangement.
If the pension fund is worth more at age 75 than it was when crystallised, less the tax free cash, then that growth is tested against any remaining unused LTA.
If you are over, then you either have to draw some pension to get you under or pay a 25% tax charge on the excess.
I appreciate you writing those scenarios because I want to understand this.
From the link I sent you earlier, the LTA check at 75 looks at:
1. uncrystallised money purchase funds (Mr Y has £500k at 75)
2. uncrystallised defined benefits (Mr Y has none at 75)
3. a second test on drawdown funds (Mr Y has none at 75 - all crystallised funds were taken as income using 1% of LTA each year for ten years)
Another point is that (unless I have missed something) Mr Y won't be paying 40% tax on anything. A DB pension with an LTA value of £500k is £25k per year. Therefore, he has the opportunity to take an additional £25k per year as income taxable at basic rate.
As chip* said, there is a third way for Mr Y to avoid the LTA tax by crystallising the entire £480k SIPP at age 65 which will use 48% of the LTA. He would take £120k tax free cash, then take £25k per year as taxable income leaving a pot of £110k at age 75, assuming no investment growth.
Of course, taking income you don't need may not be great from an inheritance tax perspective and it will be too much to put into an ISA.
From the link I sent you earlier, the LTA check at 75 looks at:
1. uncrystallised money purchase funds (Mr Y has £500k at 75)
2. uncrystallised defined benefits (Mr Y has none at 75)
3. a second test on drawdown funds (Mr Y has none at 75 - all crystallised funds were taken as income using 1% of LTA each year for ten years)
Another point is that (unless I have missed something) Mr Y won't be paying 40% tax on anything. A DB pension with an LTA value of £500k is £25k per year. Therefore, he has the opportunity to take an additional £25k per year as income taxable at basic rate.
As chip* said, there is a third way for Mr Y to avoid the LTA tax by crystallising the entire £480k SIPP at age 65 which will use 48% of the LTA. He would take £120k tax free cash, then take £25k per year as taxable income leaving a pot of £110k at age 75, assuming no investment growth.
Of course, taking income you don't need may not be great from an inheritance tax perspective and it will be too much to put into an ISA.
LeoSayer said:
Mr Y won't be paying 40% tax on anything. A DB pension with an LTA value of £500k is £25k per year. Therefore, he has the opportunity to take an additional £25k per year as income taxable at basic rate.
Although don't forget,Mr Y will be drawing State Pension c.£10k p.a. as well (which is taxable income).
Mr Y may still be in some form of employment, pushing up his overall income.
Mr Y may have investment income from a general investment account with taxable dividends that push up his overall income.
One additional point I will mention is that wealthier pensioners need to watch out if they suddenly try to draw down a lot of income to dodge the LTA tax charge. An effective 60% income tax band lurks on income between £100k-£125k p.a. and then at £150k p.a. the 45% income tax rates kicks in. So fat cats need to to plan ahead!
Edited by anonymous-user on Thursday 17th December 10:05
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