LTA combined DC/DB

shinytop

Hopefully a simple question. If a £500k DC pension were crystallised and then a year later a £30k per annum DB pension started how would any tax due because of LTA excess be paid? Would a bill be sent or would it be deducted from the DB pension?

hugheskevi

Assume Lifetime Allowance (LTA) is £1m (for ease, it is current £1.055m increasing in line with CPI).

The £500K DC pension uses 50% of the LTA.

The £30K DB pension is valued at £30K x 20 = £600,000, or 60% of the LTA (noting that in reality the LTA would have increased in line with CPI).

This breaches the LTA by £100,000. There was no lump sum taken, although as any lump sum would crystallise before income it wouldn't matter even if a lump sum had been taken in this case. Therefore, the charge on the breach is 25% of the excess, so £100,000 x 25% = £25,000.

The pension scheme is jointly liable for the charge, so will calculate by how much the annual DB pension would be reduced to pay a charge of £25,000. If they used the same factor as HMRC (which is unlikely, but it will probably be something like that), 20:1, then the reduction to pension would be £25,000 / 20 = £1,250. This is applied as a pension debit to the pension before the pension comes into payment, and the scheme pays £25,000 to HMRC.

anselld

It would be better to delay full crystallisation of the DC to allow the DB to be paid in full. Then take the LTA penalty on the DC instead.

The_Doc

If at the point of crystallisation of the DB pension you were £100K over the LTA, then the DB scheme administrator would need to pay the necessary charge.

If you took the pension as income, then the DB administrator would need to pay £25K and your pension would be reduced accordingly depending on the commutation rate (rate at which lump sums and annual pension amounts are converted). The value of the commutation rate will determine if this is a good option to choose or not.

Another possibility would be to reduce any lump sum that you would receive. In this case the LTA charge would be £55K (assuming there is enough available tax free lump sum to pay this).

I guess the scheme may allow you to pay this from outside the pension if you wished, but this is usually the least tax effective option.

What possibilities are actually available to you depend on the scheme rules.

The_Doc

anselld wrote: »

It would be better to delay full crystallisation of the DC to allow the DB to be paid in full. Then take the LTA penalty on the DC instead.

That would depend on whether the commutation rate is favourable or not.

If you have a LTA tax charge of £10K and a commutation rate of 33:1, then a £303 annual reduction in your pension would be a good deal.

If your commutation rate was 12:1, then your pension would be reduced by £833 per year. In this case it may be better to pay it from the DC scheme.

shinytop

Thanks all, that's the conclusion I was coming to but it's nice to have confirmation.

It would be better to delay full crystallisation of the DC to allow the DB to be paid in full. Then take the LTA penalty on the DC instead.

Yup, what I was thinking.

Another option would be to take the DB pension slightly early (perhaps not as early as would be needed in my example). In a marginal situation avoiding an LTA charge might make that worthwhile.
And yes I know it's a nice problem to have ...