This is the second of two articles explaining the importance of your 75th birthday for pension planning purposes. The first article, published in September’s newsletter, looked at what your nominated beneficiary(s) might inherit from your pension if you die either side of age 75. This article examines the interaction between age 75 and the lifetime allowance (LTA) charge.
The LTA charge was introduced in 2008 as a means of levying an extra tax on large pension funds. The current position is that any pension in excess of £1,073,100 will potentially be subject to a LTA charge unless you have a ‘protected’ higher pension allowance.
If you reach age 75 with a pension fund that is large enough to attract a LTA charge, your pension provider will check to see if any LTA charge is due to be paid to HMRC. The LTA charge is 25% of the value of your pension fund that is in excess of your LTA allowance.
So, for example, if your LTA allowance is £1,073,100 and your pension fund is valued at £1,200,000 on your 75th birthday, the ‘excess value’ that would be subject to the LTA charge is £126,900. This would result in a LTA charge of £31,725 (being 25% of the ‘excess value’).
If you had taken out your full tax free cash entitlement prior to your 75th birthday then the LTA charge could be calculated on a higher ‘excess value’. This is because the tax free cash withdrawal would have been deemed to have used up all, or part, of your lifetime allowance, depending upon the value of the fund when the tax free cash was taken.
To put figures around this, if you had a LTA allowance of £1,073,100 and you drew out all of your 25% tax free cash entitlement when your pension reached its LTA allowance, at say age 70, you would have withdrawn (25% of £1,073,100) £268,275, using up 100% of your lifetime allowance, leaving £804,825 in your pension.
If your remaining pension fund then grew significantly to reach a value of £1,200,000 by the time you were age 75, the value that would be assessed to the LTA charge at age 75 would be (£1,200,000 – £804,825) £395,175. Resulting in a LTA charge of £98,793 (25% of £395,175).
Is there any action you should take leading up to your 75th birthday?
You can avoid paying a LTA charge if you:
- withdraw your tax free cash entitlement before your pension fund exceeds your LTA allowance andbefore you reach your 75th birthday; and
- you also withdraw any subsequent growth in value in excess of your LTA allowance before you reach age 75.
Whether a strategy of withdrawing the growth in excess of your LTA allowance is appropriate for you will depend on your overall inheritance tax (IHT) position and your rate of income tax.
If you are, for example, a 40% taxpayer, you will pay 40% income tax on withdrawals from your pension and if you don’t spend or give the money away during your/your spouse’s lifetime your estate will have to pay a further 40% IHT on the death of the second of you: this is a combined tax rate of 64%. By comparison, any money left in the pension will suffer a 25% LTA charge but will then be available to your beneficiary(s) to withdraw at potentially a 20% rate of income tax, so a combined tax rate of 40%.
Seek advice
This is a complicated area with different moving parts and the ‘correct answer’ will vary depending on individual circumstances. Do seek advice as you approach (or well in advance of approaching) age 75 to make sure that you follow the most appropriate tax mitigation strategy.
Photo by BBH Singapore on Unsplash