Although most individuals with pension funds exceeding £500,000 are aware of the pension Lifetime Allowance and its implications many are unaware that there are a number of options to protect themselves from a significant tax bill.
If the Lifetime Allowance of £1m held in an individual’s pension fund is exceeded any pension benefits taken as a lump sum are taxed at 55%, while benefits taken as a pension are taxed at the individual’s marginal rate plus an additional 25%. The Government backed Pension Advisory Service recommends “you should take action if the value of your pension benefits is approaching, or above, the lifetime allowance.”
What Is The Pension Lifetime Allowance?
The pension lifetime allowance is the maximum amount any individual can hold in a pension fund before attracting a tax charge. The level of the lifetime allowance has reduced by over 40% since 2009 and currently stands at £1m. The tax charge only applies to any amounts above the lifetime allowance limit.
A test is made against the lifetime allowance each time a pension fund is accessed (a benefit crystallisation event). The lifetime allowance applies to the value of the pension fund at the time benefits are first accessed – not its value today. A second Lifetime Allowance test is made when an individual reaches 75 years of age. So if a pension fund continues to grow during retirement and / or benefits are not taken there is a risk of a Lifetime Allowance charge at 75 years of age.
Calculating Lifetime Allowance
What may seem an average pension contribution today can, over many years can build into a pension fund that exceeds the Lifetime Allowance, particularly if the pension holder is a member of a defined benefit (Final Salary) pension scheme.
To make a quick assessment if you are near the lifetime allowance limit add the value of
- Any DC schemes including SIPP at the current value
- Any Final salary pensions not in payment at 20x minimum the annual pension due
For those near retirement it is relatively easy to make a judgement based on this total. However, for those between 45 and 55 years of age who must assess the long term impact of contributions and future growth rates the calculation can be more of a problem.
A 45 year old with a current defined contribution pension fund total value of approximately £600,000 could expect to exceed the lifetime limit if planning to retire at 60, depending on their level of contribution. Those over 45 with final salary pensions, who are higher earners should be particularly cautious.
How Is Lifetime Allowance Measured
Taking a simplified view of the complex pension Lifetime Allowance rules, whenever benefits are taken from a pension fund a percentage of the LTA is used up. For Defined Contribution schemes the lifetime allowance is measured when an individual moves into a drawdown arrangement, takes a lump sum or purchases an annuity. For Defined Benefit (final salary) schemes Lifetime Allowance is measured at the points benefits (or lump sum) are first taken.
When an individual reaches 75 years of age any pension benefits not taken (or in drawdown at that point) are measured against the Lifetime Allowance. A measurement is also taken against the Lifetime Allowance if a transfer is made to a ROPS scheme before age 75.
What Action Can You Take
It may be possible to protect pension savings from the Lifetime Allowance (known as fixed or individual protection) but it is a highly complex area of tax regulation and it is important to take professional advice. A wrong move can be costly and there is the added risk of a significant fine from the tax authorities if procedure is not followed and the appropriate declarations made at the specified time.
There are other options worth considering based on individual circumstances but it is important to take professional advice and consider both the benefits and the risks. Should you require an initial (no obligation) discussion to establish the best way forward given your individual circumstances please do not hesitate to get in touch on 0800 043 8341 or email firstname.lastname@example.org.
The information in this article does not constitute financial or other professional advice. You should not take action on the basis of this article without seeking regulated independent financial advice that addresses your specific circumstances.