Effect of busting Lifetime Allowance

point5clue

I've been playing with a spreadsheet today and looking at a scenario where I retire at 53 with four years of living off ISA investments before starting to draw down from pension pot.

With my (I think) pessimistic growth assumption of 3.5pc pa the pension pot is just under the LA. However it has just occurred to me, that I'm thinking 3.5pc real growth, but the LA figure has no pity for the effect of inflation and unless it is raised in the mean time a higher actual growth value will bust the LA before I can touch the pot and crystallise it.

But I don't want to reduce payments into my pension 'just in case' if the consequenses are neutral or an acceptable risk/reward.

Is there an easy rule of thumb to understand the effect on the 60pences of income I give up whilst working that show up as pounds in the pot if they turn out be ones that are 'over the top' ?

I guess it depends on the growth ? Does the tax penalty just eliminate the benefit of the grossing up, so that it would have been the same as putting it in an ISA or is it punitive ?

ermine

HMRC's guidance is your friend. As is this illustration

The LTA is valued when you take your benefits, it appears you can go over but if there is a humdinger of a market crash you could still end up below.

Presumably you could divert savings into ISAs as you approach the limiting case with your savings + projected growth. Or shift to less volatile assets as you approach it, which would take some risk off the table, also worth having.

zagfles

You can go quite a bit over the LTA and still be a basic rate taxpayer in retirement if you drawdown at around the rule of thumb "safe" rate of 4%.

In which case the effective tax rate on the way out for the amount above the LTA is 40% if you take the income option.

If you're getting 40% tax relief on inputs then it's tax neutral to using an ISA. Growth makes no difference assuming the same ISA/pension growth.

But you'll be significantly worse off if you go above the basic rate band when drawing down (55% on the way out).

Of course tax rates and LTA charges etc could change which would change the calculation...

point5clue

I've created yet another tab in my spreadsheet to try some things.

Can someone check my understanding (and my maths ?) because it seems to me that over shooting is still better than putting the money into an ISA which I find strange.

Assume my Pot is exactly £1M at the start of the day before I crystallise. One day to eliminate growth from the equation (though I don't think it matters now)

Simple one first - pay my HR tax on that £1.66 and put £1 in to an ISA (day before I retire so zero growth till crystallisation). End result £1

Alternatively put £1.66 into my SIPP and earn a pound less.
Next day crystallise. The pound over a mil gets 25p removed (I'm taking it as income) leaving £1.245p. I take a quarter tax free (31p) and three quarters at BR tax (74.7p)
End Result: £1 and 5.8p

I think the maths stands for a million and one pounds or ten million.

Now my head hurts - can anyone spot a mistake ?

zagfles

point5clue wrote: »

I've created yet another tab in my spreadsheet to try some things.

Can someone check my understanding (and my maths ?) because it seems to me that over shooting is still better than putting the money into an ISA which I find strange.

Assume my Pot is exactly £1M at the start of the day before I crystallise. One day to eliminate growth from the equation (though I don't think it matters now)

Simple one first - pay my HR tax on that £1.66 and put £1 in to an ISA (day before I retire so zero growth till crystallisation). End result £1

Alternatively put £1.66 into my SIPP and earn a pound less.
Next day crystallise. The pound over a mil gets 25p removed (I'm taking it as income) leaving £1.245p. I take a quarter tax free (31p) and three quarters at BR tax (74.7p)
End Result: £1 and 5.8p

I think the maths stands for a million and one pounds or ten million.

Now my head hurts - can anyone spot a mistake ?

You don't get tax free cash over the LTA.

Make it £1.6666666.., in the SIPP. That makes it £1.25 after the LTA charge. After basic rate tax £1 exactly. Tax neutral, like I said above!

neilvw

Your scenario involves crystallising £1,000,001.66 ?

I'm assuming there is no LTA protection in place.

In that case, the maximum tax-free cash is 25% of £1 million = £250,000. So you can't take 25% tax-free from the excess.

The extra £1.66 you take over the LTA can either be taken as income taxed at 25% and then 20% if you are a BR taxpayer => 40% overall tax (66p), you're left with £1.

Or as a lump sum taxed at 55% which would be daft as a BR taxpayer as it would leave you with 75p.

(edit: basically what zagfles said!)

point5clue

Thankyou - really helpful - my takeaway - undershooting the LA has a definite penalty, overshooting it does not (though no additional benefit).

I will aim to hit the LA with a conservative growth assumption, and not worry if growth is better (nice problem to have:T )

stoozie1

Have you factored in the LTA rising with inflation each year from 2018?

ex-pat_scot

stoozie1 wrote: »

Have you factored in the LTA rising with inflation each year from 2018?

Whilst my spreadsheet does indeed index the LTA each year, I have zero expectation that in 7 -odd years' time, when I will be first able to access my funds, the LTA will look anything like the £1m, indexed or not.


I #hope# that the whole sorry mess will be destroyed, and that the sensible throttle of Annual Allowance will be used as the pragmatic control over appropriate limits to pension tax relief.


However we are in a current climate of "bash the rich", and anyone remotely touching either the £40,000 AA or £1m LTA is viewed as fair game for "just a little bit more for the sake of the many". As such, any concession or removal of this will be seen as the chancellor giving valuable tax breaks to His Chums (registered trade mark pending).

Malthusian

stoozie1 wrote: »

Have you factored in the LTA rising with inflation each year from 2018?

You mean like it was going to rise with inflation from £1.8 million each year from 2010/11?

kidmugsy

point5clue wrote: »

With my (I think) pessimistic growth assumption of 3.5pc pa ...

I think you may be wise to practise at your pessimism a bit more.