LTA Question for a DC Pension

[matt21]

Hi All

I'm currently 36 with a reasonable pension for my age and I'm a 40% tax payer. I've decided for the next decade or so to put as much as I can in my pension whilst I can afford it. However, I am concerned that this action will likely result in me being over the LTA come retirement. This pension is a Defined Contribution pension.

If I retire at 65 and my pension is for example £100k above the LTA, will I pay the additional 25% on top of tax on only the value above the LTA? Would the calculation for annual tax be £100k / 25 years / 25% = £1000 / year? Or am I over simplifying?!

I've found a lot of info on DB pensions, but not 100% clear on DC. It is far off but maybe my strategy over the next decade should differ.

Thanks!

[LordGrover]

A heck of a lot may change in thirty years... I'd not worry until you get closer to the limit/the time you plan to retire.

[LeoSayer]

You only pay the LTA tax when you have crystallised pension(s) with a total value greater than the LTA. Crystallisation is another word for taking a pension eg. commencing DB or taking tax free cash.

For example, if the LTA is £1m, then you don't pay the tax if you crystallise £1m. If you crystallise another £100k then you will pay £20k tax. There's a lot more complexity around crystallisation events but that's the basics. In other words, you may not pay the tax until age 75+.

The DB LTA calculation is simple. You multiply your annual pension at commencement by 20. So £10k becomes £200k for LTA purposes.

After spending way too much time researching LTA I've come to the conclusion not to worry about it too much even though I am very likely to pay the tax. Tax efficiency is an important factor but there are many other financial planning and non-financial considerations.

There are various measures you can take to mitigate the tax now and in the future but it's also useful not to have all your eggs in one (tax) basket both for future flexibility and because the taxation and pension regime is subject to change. A lot can change (politically and in your life) in the 30 years between now and your retirement.

However, the regime for making contributions is very good for higher rate taxpayers right now, particularly if you can contribute via salary sacrifice.

[matt21]

Thanks both. I know it's far off so probably shouldn't be too concerned.

What I struggled to understand is the 20 x annual pension driving the LTA amount. Surely on a DC scheme I can decide how much I draw down, so even if a pot is bigger than the LTA, if say £40k/year was pulled out then there would be no tax (£800k), right?

[LeoSayer]

matt21 said:

Thanks both. I know it's far off so probably shouldn't be too concerned.

What I struggled to understand is the 20 x annual pension driving the LTA amount. Surely on a DC scheme I can decide how much I draw down, so even if a pot is bigger than the LTA, if say £40k/year was pulled out then there would be no tax (£800k), right?

The x 20 multiplier only applies to DB.

For DB, if you commence a £40k pension then your value for LTA is £800k - meaning you have used 80% of the LTA (if LTA is £1m).

For DC, the % of LTA used is based on the amount you crystallise. Let's say you crystallise £40k every year on top of your DB pension for 7 years then the calc is like this:
Year 1: £40k = 4% of LTA used making total used 84%
Year 2: £40k = 4% of LTA used making total used 88%
Year 3: £40k = 4% of LTA used making total used 92%
Year 4: £40k = 4% of LTA used making total used 96%
Year 5: £40k = 4% of LTA used making total used 100%
Year 6: £40k = 4% of LTA used making total used 104% (LTA tax due = 20% of £40k)
Year 7: £40k = 4% of LTA used making total used 108% (LTA tax due = 20% of £40k)

You should note there is an automatic crystallisation event at age 75 for remaining funds not yet taken as income or crystallised. See here for all:
https://www.gov.uk/hmrc-internal-manuals/pensions-...

[Armitage.Shanks]

Why on earth would you want to retire at 65 with a maxed out pension? Surely the idea of overpaying into your pension is so you can acquire a good return to retire early and enjoy the benefits. At 65 you’ve only got a few years before the government will give you another £10kpa at todays return.

I’d aim for 55 and enjoy life without the hassle and interference of work

[matt21]

Good feedback everyone, thank you. Never thought of planning to retire at 55, it seems so young! Depending how the next 10 years goes maybe that will be an option.

[duckson]

You won’t be able to draw the pension at 55 as it’s changing to 57 from 2028. Of course you could have other non-pension monies to bridge the gap until you can draw your DC pension.

[EllipticSwerve]

I appreciate why you’ve said this as it’s the headline fact, however, as I understand it (and I might be wrong) there are some nuances such as depending on how your pension was worded when the ‘state age minus ten years’ legislation was proposed, you may in some cases ignore it. I think there’s some consultation period going on currently… eta in reply to duckson.

[OddCat]

Armitage.Shanks said:

Why on earth would you want to retire at 65 with a maxed out pension? Surely the idea of overpaying into your pension is so you can acquire a good return to retire early and enjoy the benefits. At 65 you’ve only got a few years before the government will give you another £10kpa at todays return.

I’d aim for 55 and enjoy life without the hassle and interference of work

^^^^^^ This, all day long. Even if you can't take your pension till 57, fund an ISA too so you can cash that in and cover the extra 2 years between 55 and 57.

Unless you are in love with your job, every additional unnecessary day working is a day wasted !