Lifetime Allowance Query

crazychamps

Hi All,

Thanks in advance for all the help.

I have a few queries regarding the LifeTime pension Allowance (LTA).

Age: mid 20s
DC pension

Does the LTA only apply if you are resident in the UK when you are drawing down your pension (i.e. if I decide to retire abroad or leave a few years before retiring, will I still be hit by the LTA)?

[LIST=2]I currently contribute ~ £6k a year (maxed out employer pension contributions). I am a higher rate tax payer, which is why I am considering increasing my pension contributions by ~£4k to bring yearly contributions to £10k. However I am faced with a small delima.

Running the figures with a 5% annualised growth, I would pass the lifetime allowance if I continue to contribute until I am 68. Also, if I retire at 55 and do not withdraw excessive amounts, I would also pass the lifetime allowance if I have kept some of the amount invested until 75 and not taken a huge amount before then to hold in ISAs or investment accounts.

I appreciate that 5% annualised growth after retirement may require one to hold risky assets, but let's keep this assumption for now.

Is the 25% charge (assuming the drawdown pension as income) charged as you take the pension or on the full pension pot that exceeds the LTA on a specific date (i.e. the date of crystallisation)? If the latter, does this mean that the 75% remaining can continue to grow through investments without incurring further LTA taxes (other than income tax)?[/LIST]

[LIST=3]Also, if one is expected to surpass the LTA, is it more tax efficient to continue contributing to benefit from employer contributions (assuming I am still a high rate tax payer)? Therefore, the rest of the salary is then better to take now as income. [/LIST]

[LIST=4]Alternatively, is an option for one to hold low risk investments in their pension after a specific age (or after LTA is surpassed) and the high risk investments in ISAs, LISA? [/LIST]

Personal note: the lifetime allowance seems quite low as most high rate tax payers could surpass it if they start contributing early on.

FYI – I have read this article which helps tremendously to answer some initial questions that I had https://forums.moneysavingexpert.com/discussion/5800682/how-do-lifetime-allowance-charges-work

NoMore

The intention is the LTA will also increase with inflation. Have you factored that into your calculation ?

Usual advice is not too worry about the LTA until your close to it.

Paul_Herring

I currently contribute ~ £6k a month (maxed out employer pension contributions). I am a higher rate tax payer, which is why I am considering increasing my pension contributions by ~£4k to bring yearly contributions to £10k.

Something's not right there... should that initial figure be £6k per year (for £500 per month.)

Because at £6K per month, you'd be bumping up against the £40K/year limit after the 6th month..

Albermarle

Personal note: the lifetime allowance seems quite low as most high rate tax payers could surpass it if they start contributing early on.

Higher rate taxpayers benefit disproportionately from pension tax relief and in the past some very high earners exploited this to the maximum . Hence the LTA of one Million Pounds to restrict the very high cost to the Treasury of the tax relief .
I think you can say if you are worrying about the LTA , it is a very nice problem to have !

EdSwippet

crazychamps wrote: »

Does the LTA only apply if you are resident in the UK when you are drawing down your pension (i.e. if I decide to retire abroad or leave a few years before retiring, will I still be hit by the LTA)?

Yes. One way to defuse it, though, is to transfer to a QROPS. However, you would need to do that before reaching the LTA, since QROPS transfer is a 'benefit crystallisation event' -- that is, there is an LTA test and potential for an LTA penalty on this type of transfer.

Once your pension is out of the UK there are no further entanglements with the LTA. However, QROPS is only worth considering if you will genuinely leave the UK, and there are some fiddly rules about which country to transfer pensions to. And QROPS transfers come with their own set of possible problems as well, so there is the potential for frying-pan-to-fire in this type of move.

crazychamps wrote: »

I currently contribute ~ £6k a month (maxed out employer pension contributions). I am a higher rate tax payer, which is why I am considering increasing my pension contributions by ~£4k to bring yearly contributions to £10k.

Did you mean £6k a year, currently?

crazychamps wrote: »

Running the figures with a 5% annualised growth, I would pass the lifetime allowance if I continue to contribute until I am 68. Also, if I retire at 55 and do not withdraw excessive amounts, I would also pass the lifetime allowance if I have kept some of the amount invested until 75 and not taken a huge amount before then to hold in ISAs or investment accounts.

5% annualised real return -- that is, after inflation at perhaps 2-3% -- might be optimistic. 4% real is perhaps closer, though even that may be a touch on the highish side. It is generally easier to work with real return, since that way you don't have to factor in that the LTA is (for now, anyway!) set to rise with inflation. How do your numbers look with 4% annualised return instead of 5%?

crazychamps wrote: »

Is the 25% charge (assuming the drawdown pension as income) charged as you take the pension or on the full pension pot that exceeds the LTA on a specific date (i.e. the date of crystallisation)? If the latter, does this mean that the 75% remaining can continue to grow through investments without incurring further LTA taxes (other than income tax)?

The LTA is taken when you crystallise your pension, or on some other 'benefit crystallisation event' (such as QROPS above). You can crystallise all your pension (flexi-drawdown) and use the entire LTA there and then, or do it in stages (UFPLS) and so use up your LTA in small chunks. Which is best depends on your circumstances and requirements at the time.

With flexi-drawdown you can leave the 75% that remains after either 25% PCLS or 25% LTA penalty invested until ready to draw it (taxably). Your next interaction would be with the spiteful age 75 LTA test. To defuse this, draw down enough real and nominal growth at ordinary tax rates to ensure that you limbo under the LTA for this final time.

crazychamps wrote: »

Also, if one is expected to surpass the LTA, is it more tax efficient to continue contributing to benefit from employer contributions (assuming I am still a high rate tax payer)?

It is usually worth continuing contributions where there is a decent employer match to be captured, especially if your employer will not provide this as salary instead. You will need to compare the outcomes you expect. Once past the LTA, and assuming you want to draw on your pension rather than use it as an IHT bypass say, it is however generally not worthwhile contributing to pensions beyond employer match.

crazychamps wrote: »

Alternatively, is an option for one to hold low risk investments in their pension after a specific age (or after LTA is surpassed) and the high risk investments in ISAs, LISA?

If you hold a mix of high-risk/return and lower-risk/return then it certainly makes sense to keep the lower growth items in the pension. That way you lessen the long-term corrosive effect of the LTA penalty.

crazychamps wrote: »

Personal note: the lifetime allowance seems quite low as most high rate tax payers could surpass it if they start contributing early on.

I'm not sure about 'most' -- many folk, even in higher rate tax, pay as little as they can into pensions and pay them no attention whatsoever. However, this is part of the treachery that is the repeated lowering of the LTA. It is clearly designed to be largely invisible until unavoidable.

EdSwippet

Albermarle wrote: »

Higher rate taxpayers benefit disproportionately from pension tax relief and in the past some very high earners exploited this to the maximum . Hence the LTA of one Million Pounds ...

The LTA was introduced in 2006 at £1.5MM and was £1.8MM as recently as 2010/11. It's an extremely poorly designed way of restricting pension tax relief since it applies to the entire pension value, not just the contributions. This flaw in its construction could be somewhat overlooked as it then broadly achieved what it set out to achieve.

However, the successive reductions are effectively retroactive tax increases that have transformed it into something much more malign. Its current value is around 1/3 of its peak in real terms, and that's a huge yet largely hidden tax increase that can readily been seen in the ballooning numbers of people who are being clobbered by it.

The LTA currently operates more like a stealth tax dragnet than a targeted tax backstop. It has perverse incentives built into it that are now causing real damage to important services.

crazychamps

Thanks everyone for the responses and thanks to EdSwippet for the detailed response. My response and further questions are below.

NoMore wrote: »

The intention is the LTA will also increase with inflation. Have you factored that into your calculation ?

Usual advice is not to worry about the LTA until your close to it.

Using the 5% growth in investment as real return would take inflation into account and allow me to ignore it from the calculation (unless the government changes the LTA increase by inflation rule).

Paul_Herring wrote: »

Something's not right there... should that initial figure be £6k per year (for £500 per month)

Thanks for catching it out. I did mean £6k per year (~£500 a month).

EdSwippet wrote: »

Yes. One way to defuse it, though, is to transfer to a QROPS. .... And QROPS transfers come with their own set of potential problems as well, so there is the potential for frying-pan-to-fire in this type of move.

I'll research some more into QROPS but thank you for this detailed information, it helps alot.

EdSwippet wrote: »

5% annualised real return -- that is, after inflation at perhaps 2-3% -- might be optimistic. 4% real is perhaps closer, though even that may be a touch on the highish side. It is generally easier to work with real return, since that way you don't have to factor in that the LTA is (for now, anyway!) set to rise with inflation. How do your numbers look with 4% annualised return instead of 5%?

I am controlling my investment myself as the default funds that my company uses seem to take a very cautious approach and have a high home bias percentage. I have added your suggestion of 4%, at current contributions I would break LTA around 75 and at increased contribution levels (~£10k) I would break it at 65.

From my understanding of the current legislation, I can defer any LTA charge until age 75 as long as I drawdown a sum below the LTA, meaning that if a pension pot is £1.5 million (and using an LTA threshold of £1million for ease), I can drawdown a benefit of £650k before I am 75 and then at 75, the remaining £850k will be below the LTA threshold and I would not suffer that LTA penalty, is that correct?

Also, as the LTA charge for drawdown is 25% before accounting for income tax, if I live abroad during my drawdown, is it correct that I do not have to pay UK income tax on state and personal pensions? This could prove beneficial depending on the income tax rates of the country that I may reside in at the time.

EdSwippet wrote: »

It is usually worth continuing contributions where there is a decent employer match to be captured, especially if your employer will not provide this as salary instead. You will need to compare the outcomes you expect. Once past the LTA, and assuming you want to draw on your pension rather than use it as an IHT bypass say, it is however generally not worthwhile contributing to pensions beyond employer match.

The way I see it, and please correct me if I am wrong, is that:

• Taking income home is £58 for every £100 earned (40% income tax + 2% NI)
• Contributing to pension that exceeded LTA is £100 + £110 (employers contribution inc. salary sacrifice) * 55% LTA penalty rate, leaves £94.5 after draw down.

This means it is still better to contribute to the pension when matched by employers contributions despite the pension likely surpassing the LTA limit; or have I forgotten a key factor?

Thanks again.

EdSwippet

crazychamps wrote: »

From my understanding of the current legislation, I can defer any LTA charge until age 75 as long as I drawdown a sum below the LTA, meaning that if a pension pot is £1.5 million (and using an LTA threshold of £1million for ease), I can drawdown a benefit of £650k before I am 75 and then at 75, the remaining £850k will be below the LTA threshold and I would not suffer that LTA penalty, is that correct?

If only escaping the LTA penalty were that simple.

On your numbers, if you took £650k at age 55 that would give you £162.5k tax free and £487.5k taxable to draw down as and when, and use 65% of your £1MM LTA. Then, at age 75 your pensions are again tested against the LTA. Even if you have taxably drawn and spent the entire £487.5k over the 20 years, the remaining £850k still exceeds the 35% of the LTA still available to you, leaving you with an LTA penalty of 25% of £500k.

Scottish Widows has a decent paper on this here:
https://adviser.scottishwidows.co.uk/assets/literature/docs/FP0647.pdf

crazychamps wrote: »

Also, as the LTA charge for drawdown is 25% before accounting for income tax, if I live abroad during my drawdown, is it correct that I do not have to pay UK income tax on state and personal pensions?

HMRC suggests that UK pensions are UK taxable no matter where you live:
https://www.gov.uk/tax-uk-income-live-abroad

Some countries have tax treaties with the UK that reserve taxing rights to the country of residence, for example the US. However, that's not going to get you a tax-free pension, just taxed by another country instead of the UK.

crazychamps wrote: »

Contributing to pension that exceeded LTA is £100 + £110 (employers contribution inc. salary sacrifice) * 55% LTA penalty rate, leaves £94.5 after draw down.

At a 100% (or 1-for-1) employer match, definitely worth contributing beyond the LTA.

One final thought. At age 'mid 20s', projecting 40 years into the future is really far too much of a reach to hope for any realistic predictions. By all means keep an eye on the LTA, but at this stage it is probably much too early to act on it. Also, remember that you don't have to wait until age 65, 68 or whatever to retire. If you pass age 55 and find that your pension has reached the LTA earlier than anticipated, you can just simply retire there and then -- that's what I did, although for me it was less a case of my pension balance growing to the LTA and more one of the LTA being shrunk down to my pension balance.

Over a 35 year working career I have lost count of the number of different pension saving regimes I have been enrolled in. Pensions are a recurrent political football, and as we've seen over the past decade, virtually no budget comes and goes without disrupting them. With at least 30-40 more budgets to go before you retire, fine-grained planning out to retirement is clearly simply impossible. Just put in what is optimum for your current circumstances and simply keep a weather eye out for storms on the horizon would be my suggestion.

Albermarle

One final thought. At age 'mid 20s', projecting 40 years into the future is really far too much of a reach to hope for any realistic predictions

Yes I do not think anyone would bet much on the 40% tax relief staying the same for ever, as one example.

Thrugelmir

crazychamps wrote: »

This means it is still better to contribute to the pension when matched by employers contributions despite the pension likely surpassing the LTA limit; or have I forgotten a key factor?

If you are fortunate to benefit from an exceptional period of market return shortly before retirement. What's the issue with paying a little tax. After all it's free money you will be benefiting from. Trying to be cautious may in fact back fire. The only certainty in life is uncertainty. Control what you able to. The rest you can only move with the tide.