One of the most important elements of your overall financial planning is making provision for your retirement. We’re all living longer and being encouraged to save as much as possible to ensure a comfortable lifestyle in our (possibly) extended retirement years. However, there is a catch that many people don’t know about – the pensions Lifetime Allowance (LTA).
The LTA is a ceiling for an individual’s combined pension pots. This limits the amount you can build up in pensions over your lifetime, without potentially triggering a tax charge when you access your retirement pot.
At its peak, the LTA stood at £1,800,000 but is currently £1,073,100 and is now frozen for 5 years. With the Chancellor looking at options to pay for the pandemic, there are rumours that the LTA could be reduced further, possibly to £800,000.
The LTA is no longer just the preserve of the seriously wealthy and may already be an issue for some of you. However, a further LTA reduction could well bring the pension savings of a lot more people into the spotlight. So, what can you do about it?
How the LTA works
It’s important to understand how the LTA works before assessing whether it impacts you. If the value of your pension plan(s) exceeds the LTA, then you do not immediately have an LTA charge to pay. It is only when you trigger what is known as a Benefit Crystallisation Event (BCE) that you may create a charge. There are a number of official ‘Events’ which range from:
- Drawing benefits
- Reaching age 75
There are other factors to consider too, such as assessing what type of pension plan you have. Perhaps you have a Final Salary (Defined Benefit) scheme which will only have one BCE; or a personal/flexible pension (Defined Contribution) which may involve a couple of BCEs over the course of your life.
The latter of these pensions, as the name suggests, means you will have flexibility on how and when you can draw benefits from your retirement provisions, and this is where the majority of LTA planning can be undertaken.
In reality, every individual with a private pension will reach a crystallisation point in their lifetime, so it is important to review everything if you feel that you may, at some point in the future, exceed the LTA.
You may also be eligible to protect a higher LTA from previous years. Over the past 10 years, the LTA has reduced from £1.8m, in stages, to where it currently is today. At those particular stages, various levels of protection were available to individuals lucky enough to have pensions that exceeded the new LTA at that time. You may still be eligible to benefit from some of these protection points, and this is something worth looking into further.
Navigating the LTA charges
If you crystallise a pension that creates an LTA charge, then you have two options with different charges attached.
1) Withdraw the excess pension over the LTA as a lump sum. This will trigger a 55% tax charge, based on that excess figure
2) Leave the excess in the pension or draw it out as income. The LTA charge is reduced to 25% on the excess, however, you will also pay income tax on any future withdrawals, at your marginal rate
What should I do next?
If you think your pension funds will exceed the LTA, you need to decide what strategy to take.
Income tax, LTA charges and Inheritance tax (IHT) are all areas that can be mitigated by careful planning.
In terms of IHT, pensions do not form part of your estate that is considered for IHT on death. As a result, some individuals will leave their pensions to grow without ever touching them, spending their other assets instead, allowing more to pass tax efficiently to the family. There is an LTA charge to consider at age 75 – however, an LTA charge of 25% is lower than IHT, currently 40%. Further information on the LTA can be found on the www.gov.uk website.
Understanding your pensions can be a complicated process and we recommend that you speak to an Independent Financial Adviser who will be able to guide you. Most Financial Advisers offer a free initial consultation, which is a great opportunity to assess whether you may be affected by any changes, and to help you get the most of out of your retirement provisions in the process.
Further information on the LTA can be found on the www.gov.uk and kelland-hale.com websites.