How to Avoid 55% Tax on Your Pension – Explaining the Lifetime Allowance
If your pension is still in its early years you may not need to worry about the “Lifetime Allowance”, or LTA. But if you have paid in to a scheme for many years, whether it’s a personal pension or your employer’s scheme, then it’s important that you understand how the LTA could affect you and your future planning. Overlooking this could mean losing 55% of your pension in tax.
In the past, you were only allowed to have one tax privileged pension that you were saving into at a time, but now you can have as many as you like, as long as your contributions are within certain limits, and your total pension “pot” (excluding the state pension) is within the Lifetime Allowance. If your pot does exceed the LTA, whilst you can still save into it, there are tax charges on the value over the allowance when certain events occur.
The LTA first appeared in April 2006 when so-called “Pension Simplification” was introduced (an event that heralded an era of much more complication!), and the initial allowance was set at £1.5 million. Because the allowance was set at quite a high level, with plans to increase the amount, most people were not affected. The LTA gradually increased over the next four years and was at its highest level of £1.8M in 2010/11 and 2011/12, after which it was reduced to the original £1.5M from 2012 to 2014, then to £1.25M from 2014 to 2016, and down again to £1M from 2016 to 2018 – all at a time when pension values were increasing significantly. From 2018 it has increased in line with CPI (Consumer Price Index) each new tax year and currently stands at £1,073,100 (in 2020-21), which means that many more people are affected by this limit, although most will probably not be aware of it.
There have been various “protections” over the years that an individual could apply to HMRC for and these have been designed to retain a higher level of LTA (with various restrictions applied); Enhanced and Primary Protections initially; Fixed and Individual Protections following from 2014 onwards. If you exceed your LTA the tax privileges are recouped via the LTA charge, either on “crystallisation” of benefits, at age 75, or on death before age 75.
What are “Benefit Crystallisation Events” (BCE)?
These are basically LTA test points and, in the main, are when you are either taking lump sums and/or pension benefits, or when you reach age 75. There are nine BCE’s (full details of all of these trigger events can be found on the government website) and any pension benefits taken before 2006 are also included in these calculations to see how much of your LTA you have used.
When you take benefits from any pension arrangement, the provider will tell you how much lifetime allowance you have used when you crystallised benefits. Once you have used 100% of your LTA any further benefits are subject to the Lifetime Allowance Charge.
Excess benefits (over the LTA) if taken as a lump sum will be subject to a 55% tax charge and if taken as an income, such as scheme pension, annuity or drawdown, a 25% tax charge applies plus income tax at your marginal rate. So it’s important to plan ahead if it seems likely that you will be in this situation.
What actions do I need to take?
If you have accumulated sizeable pension funds, it’s important that you get really good advice. Don’t forget that the charge applies to the future value of your pension, so you will need to work out not only whether your funds are at or near the LTA today, but also the likely position at your expected retirement date. This can be a complex calculation, and a qualified pension specialist will be able to do the numbers for you. Look for an adviser who is a Certified or Chartered Financial Planner, and check their qualifications before you appoint them to act for you.
As with all good financial advice, it isn’t just about mathematics. Of course your adviser will want to know about your pensions, your income and your tax position, but they will also ask about your future plans, your retirement goals, your career path and your aspirations, all of which could have an impact on the recommended course of action. For example, it may be worthwhile drawing your pension benefits well before your planned retirement date in order to trigger a ‘crystallisation event’ and avoid a future tax penalty. Your adviser will be able to guide you.
If you’re already a client of Chesterton House we will already have all of this information and will review your LTA position at our regular meetings. We’ve probably already been talking to you about when is the best time and most appropriate way of taking benefits to avoid or limit any LTA charge in line with your goals and whilst also taking account of your inheritance tax position, your future tax liabilities, and your aspirations. It’s all part of having a good Financial Planning strategy in place.
If you don’t have an adviser, or your current adviser doesn’t have the required expertise in this important area, we can help. Our team has decades of experience in dealing with complex pensions issues and helping people to steer a profitable and rewarding path through the maze. We’ll take time to understand your situation in depth and guide you through each step of the process. Why not take the first step and contact us today?
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