Lifetime allowance usage calculations

jkwer521

When calculating the LTA usage, I understand that there are crystallisation events, including one at age 75. My question is whether investment gains on a drawdown pot between retirement (say age 60) and 75 always count towards the LTA or whether they only count if you don’t draw them down.

Let’s say you had £800k at age 60 and you wanted to draw it down over the rest of your life. The examples I can find suggest that (ignoring tax free lump sum for now), you can move the £800k to drawdown, but it will be re-assessed at age 75. The examples given suggest that if you then end up with £1m at age 75, then the LTA assessment is on the difference of £200k. However, all the examples I have found are where the person hasn’t actually made any withdrawals from the drawdown pot.

If you have taken from the drawdown pot, how is the LTA calculation made? For example, if you start with £800k, and you withdraw £200k over the next 15 years, but the investment gains mean that the pot is still worth £750k, does the £150k of investment gains count against the LTA?

The reason I am asking is that if those gains do count towards LTA, then surely you would have to plan to be well below the LTA at age 60, given that you still have 15 years left until the last assessment. If they don’t count, then is the best strategy to be as close as possible to LTA at age 60 and then just aim to draw down the gains so you’re not further assessed against the LTA?

EdSwippet

The LTA test at age 75 is based on the remaining value of the drawdown pot, so it applies to any growth that has not already been taken as income.

Does the example of 'Simon' on page 2 of this Scottish Widows paper help? 'Simon' takes no income and so is hit with a painful LTA tax charge, but the paper goes on to say:

The rules encourage drawing down growth in excess of any LTA ‘headroom’ as taxable income. To avoid the LTA charge Simon could have drawn down sufficient income to prevent the fund growing above the available LTA.

Now there are no limits on the amount of income that can be drawn this is largely an optional charge. The investor has the choice of paying income tax or the 25% LTA charge plus income tax later. There may still be situations where the charge is preferable – for example where the client has no intention of ever withdrawing the funds and simply wants to keep them out of their estate for inheritance tax purposes.

jkwer521

Thanks! Yes this does seem to clarify that further LTA charges can be avoided by simply taking any excess as income.

I find it strange how all the examples given are where the person does not take anything from their drawdown pot - I would have thought a more common experience would be where the person takes at least some.

I had mistakenly believed that the assessment would be against all gains, not offset against income taken, so I was aiming for "contributions + investment gains (net of fees) = LTA" at age 75, but now I can aim for age 60 instead, avoiding any further charges by drawing down at least the excess gains. This makes a huge difference.

Also my understanding is that you can only do this for the portion you move into flexi-access drawdown. If you keep the whole sum uncrystallised and take UFPLSs then you couldn't offset the gains made in the undrawn pot against the lump sums taken.

EdSwippet

I am not sure what you mean in your final paragraph, but perhaps you slightly misunderstand UFPLS.

You cannot both "keep the the whole sum uncrystallised" and take UFPLS. Each UFPLS is effectively a salami-sliced piece of your pension pot that you carve out and then crystallise so that you receive 25% of it tax-free and 75% taxed. This withdrawal uses a percentage of your remaining lifetime allowance.

For example, the lifetime allowance is £1mm, you have a £1mm pension pot, and you take £100k of UFPLS. You get £25k tax-free, £75k taxable income, £900k remains in your pot uncrystallised and you have used 10% of the lifetime allowance, leaving you 90% of it against which your remaining pot would be measured at age 75 if you (probably unwisely) left it untouched until then.

Assuming that you are over age 55 and that you expect your pension to grow faster than inflation, the tl;dr for avoiding the lifetime allowance is to crystallise the entire pot no later than when it reaches the allowance, and then take taxable drawdown from the remainder so that you again duck under the allowance test at age 75.

Pension simplification, my a---.

jkwer521

Yes you are right and reading it back my wording sounds wrong - I meant keep the whole sum uncrystallised (as opposed to moving it all to flexi-access drawdown) and then gradually crystallise by taking lump sums, and that this would be a worse outcome than crystallising it all as flexi-access and drawing down through that method (assuming you are close to the LTA).

This is an excellent summary:

EdSwippet wrote: »

the tl;dr for avoiding the lifetime allowance is to crystallise the entire pot no later than when it reaches the allowance, and then take taxable drawdown from the remainder so that you again duck under the allowance test at age 75.

One of the reasons I wasn't expecting it to be this way is that it means you can withdraw more than the LTA without breaching it. I'm sure a lot will have changed by the time I reach the age at which I can withdraw, but it's good to understand it so I can make the best plan.

EdSwippet

jkwer521 wrote: »

One of the reasons I wasn't expecting it to be this way is that it means you can withdraw more than the LTA without breaching it. I'm sure a lot will have changed by the time I reach the age at which I can withdraw, but it's good to understand it so I can make the best plan.

An alternative way to look at the lifetime allowance is that it creates a hard limit on the PCLS. No matter your pension pot size you can never realise more than 1/4 of the lifetime allowance in PCLS.

For sums below the lifetime allowance, you receive 25% of your pension tax-free and then pay tax on the remainder. For sums above it, the government takes the entire first 25% and you then pay tax on the rest. So the lifetime allowance is a pivot point at which a growing pension balance transforms from a tax benefit into a tax millstone. The fact that it moves around based on government whim is distinctly unhelpful to anyone trying to cope with it.

AnotherJoe

Hopefully some future chancellor will see the idiocy in this whole thing which penalises growth, and change it so all that matters is what you put in.

redux

AnotherJoe wrote: »

Hopefully some future chancellor will see the idiocy in this whole thing which penalises growth, and change it so all that matters is what you put in.

... and according to a couple ofthings I've seen makes doctors think about either work fewer hours, or retire early, or both