Understanding Lifetime Allowance

honeststeveo

Hi Folks.

I've still got well over 10 years till I would even be allowed to start taking my private pension (currently worth about £250K and pretty much all in equities). I can make some very sizable contributions over the next few years.

I'm mindful of the continued fiscal drag that will probably be announced in this weeks budget and am trying to ensure I don't exceed the LTA.

I was under the impression that the LTA was all about how much the total amassed in a pension but now it seems more complicated than that.

I watched a youtube video by james shack (who is great btw!) and he seemed to give the impression that you could avoid/mitigate the LTA by drawing money from the pension before it went over the 1.073M balance. So this seems to contradict my understanding. Maybe there are specifics that went over my head - this stuff is horribly complex!

So I'm trying to understand if the limit is the peak balance reached in the pension or the total amount widthdrawn since with the latter any growth once you start taking the pension probably won't reach a new max.

So that's the "target" but what about the variables? I presume it's all about equity growth, inflation and any further messing with pension laws - is that about right? Are there any easy DIY ways or tools to model scenerios to see what might play out?

Marcon

honeststeveo said:

Hi Folks.

I've still got well over 10 years till I would even be allowed to start taking my private pension (currently worth about £250K and pretty much all in equities). I can make some very sizable contributions over the next few years.

I'm mindful of the continued fiscal drag that will probably be announced in this weeks budget and am trying to ensure I don't exceed the LTA.

I was under the impression that the LTA was all about how much the total amassed in a pension but now it seems more complicated than that.

I watched a youtube video by james shack (who is great btw!) and he seemed to give the impression that you could avoid/mitigate the LTA by drawing money from the pension before it went over the 1.073M balance. So this seems to contradict my understanding. Maybe there are specifics that went over my head - this stuff is horribly complex!

So I'm trying to understand if the limit is the peak balance reached in the pension or the total amount widthdrawn since with the latter any growth once you start taking the pension probably won't reach a new max.

So that's the "target" but what about the variables? I presume it's all about equity growth, inflation and any further messing with pension laws - is that about right? Are there any easy DIY ways or tools to model scenerios to see what might play out?

Plenty of information on the web, so possibly a bit of googling on 'understanding lifetime allowance' would be no bad starting point e.g. https://www.moneyhelper.org.uk/en/pensions-and-retirement/building-your-retirement-pot/lifetime-allowance-for-pension-savings

This question also crops up regularly on this forum, so searching here should also help - the search box is at the top of the page to the left, which will help you narrow down suitable threads.

Your pension provider's website should have information about this and possibly also a modeller - but with well over 10 years to go, and the markets fluctuating so wildly, you aren't going to get any reliable figures.

One thing which is often overlooked is the use of 'small pots' - you can have up to 3 with personal pensions, each of no more than £10,000 at the time you access them, and they use 0% of the LTA (and don't trigger the Money Purchase Annual Allowance). Again, some googling will get you all the info you need.

gm0

Annual allowance to stack it up is 40k unless caught by the income taper in which case it may be less.

The rules on Life Time Allowance were applied alongside annual allowance limits to pensions partly to restrict their abuse as inheritance tax shelters for certain wealthy folk with no real intention of using them as pensions.  And of course as a method to raise money stealthily for the treasury from the rest of us in UK domiciled PAYE land. 
The design was optmised for the use of fiscal drag. 

Introduce promising indexation.  Renege.
The subsequent cuts to the LTA from its initial limit being particularly egregious in that regard.  
Again accompanied by broken promises of indexation.

Lessons are clear

The only certainty is that these rules will continue to change erratically but not in your favour.

All this crap is a cause of complexity, unintended consequence and confusion and heartburn. 

A culture of retrospective meddling creates a disincentive to saving. (Per Sunday Times article this week).

There is too much detail to cover in a single post. 

LTA sets a framework for charges for DC pots >X (and for DB via additional rules).

The LTA charge is applied when the pension is accessed not while it is being saved.

It is applied to all amounts "above the line" typically - for income scenarios at a charge of 25% ahead of income tax
There is no "tax free cash" for amounts above the line.  So this is a straight 25% confiscation (or reclaim of tax relief enjoyed earlier to taste).  Your income in retirement and whether this is higher rate band or basic rate band affects whether you come out ahead/flat/behind on the tax relief you legitimately took on the way in on the rules at the time or gobbled up greedily (to taste)

Nastily - there is a further charge on nominal growth from when accessed to age 75 done at that age if not drawn once pension to the value of the full allowance has been drawn or marked for income (crystallised in the jargon).  Or if you don't access. The untouched stuff is tested at 75 alongside the crystallised growth and anything above the line raked by 25%.

Because the allowances are meant to be indexed (but often are not as now) calculations on optimistion of LTA for different pot sizes, incomes drawn, indexation predictions vs actual inflation, returns predictions is not something that can easily be generalised about

Albermarle

As said some more  background research is the best way forward and then come back to the forum with specific questions by all means.
One critical point to get your head around is the concept of crystallising a pension. Yours will be uncrystallised until you start taking money from it. The LTA only starts to apply as you crystallise the pension.

As also said things could change at some point. As could 40% tax relief on pension contributions.

honeststeveo

Thanks for all of your responses.

OK so to clarify my question, if you watch James' video at this point he says "if you kept the balance below the LTA then no tax would be due" - This vs everything else I have read is the source of my confusion - Can someone explain therefore why in this video it seems to be about the balance rather than the amount that has been crystalised?

I've watched this video rfrom start to finish a couple of times but still can't fathom this.

PS My objective is not to obtain a full working knowledge of the LTA rules and regs as they and the thresholds will likely change (or I will have forgotten) by the time I get close to retirement but just want to understand enough now to work out what amount I should be targetting.

It seems to me it *might* be reasonable strategy to get to retirement age, review my pot size with reference to the LTA and any future reductions/freezing that are scheduled and then as James says in the video crystalise the whole lot if I'm at the threshold and there is no rise/indexing in the pipeline. I know there are a lot of uncertainty but does that sound sane?

If it is sane I then the upper bound of my target range is to reach the LTA by retirement age.

honeststeveo

gm0 said:

All this crap is a cause of complexity, unintended consequence and confusion and heartburn. 

This is so true. Everything relating to tax in this country is so obscenely complicated it burdens everyone and erodes certainty when planning to the point it might turn out to be a total waste of time

Mutton_Geoff

An important point is not to let the tax tail wag the investment dog as IFAs like to say. LTA exceedance tax is 25% plus then any income tax on the drawdown (eg 20% or 40%). For £1,000 over the LTA this costs a 20% tax payer £2,500 in LTA tax then £1,500 income tax on the balance, ie 40% equivalent or for a higher rate tax payer, 25% then 40%, total £4,500 tax, ie 55% equivalent rate but they could have been saving into the pension avoiding loss of personal tax code (income band £100k to £125k) plus 2% NI if your employer allows salary sacrifice contributions (equiv rate 62%) so still be better off (subject to their investment choices) than choosing not to contribute above some future unknown LTA limit.

As your recommended You Tuber says at 13'30", going over your LTA "is a nice problem to have".

tiring33

honeststeveo said:

Thanks for all of your responses.

OK so to clarify my question, if you watch James' video at this point he says "if you kept the balance below the LTA then no tax would be due" - This vs everything else I have read is the source of my confusion - Can someone explain therefore why in this video it seems to be about the balance rather than the amount that has been crystalised?

I've watched this video from start to finish a couple of times but still can't fathom this.

What you're missing is that, at the point of the video you linked above, James Shack is talking about the LTA test at 75 where your crystallised drawdown pot will be tested against it's value when it was first crystallised.

Unfortunately the LTA test at 75 doesn't just test uncrystallised funds, it also tests any growth in your crystallised funds.

For this reason James is correctly pointing out that you can't just forget about your crystallised funds once they have moved into your drawdown pot, you should ensure that you withdraw enough from your crystallised pot prior to your 75th birthday so that you don't get hit with a 2nd LTA charge on the amount these crystallised funds have grown.

For most people this shouldn't be a problem as they will be withdrawing money from their drawdown/crystallised funds to spend in retirement. It should really only effect those people with very large crystallised pots who struggle to withdraw the growth during their pre 75 years and frankly anyone in that position can probably afford to pay a little extra in LTA charges.

Sorry if this sounds complicated, it just is. The LTA is fairly straight forward once you get your head around it, but unfortunately that can take quite a bit of research. To be fair to James Shack he clearly understands it and has done a good job with his diagrams, but it just isn't that easy to explain.

As far as your strategy is concerned it sounds sane enough to me, but it really depends on your circumstances. Get to retirement age with a pension pot at exactly your LTA, crystallise the lot, take your tax free cash and head off into retirement. You then just need to ensure that, by the time you reach 75, you've withdrawn enough from your drawdown pot that it is not more than the amount you originally put into drawdown, if it is you will pay an LTA charge on the amount it has grown (as you will have used 100% of your LTA when you originally crystallised).

Whether you want to follow the above plan depends on your circumstances. Crystallising your full pot means taking all of your tax free cash which is then inside your estate. Die the next day and the government will take 40% Inheritance Tax from it, keep it in your pension and it can bypass IHT. Or maybe IHT isn't an issue for you (below IHT threshold, no dependents etc.) - as I said, depends on your circumstances.

Albermarle

It seems to me it *might* be reasonable strategy to get to retirement age, review my pot size with reference to the LTA and any future reductions/freezing that are scheduled and then as James says in the video crystalise the whole lot if I'm at the threshold and there is no rise/indexing in the pipeline. I know there are a lot of uncertainty but does that sound sane?

 I agree with the comments in the posts above but would just add one point. When you crystallise a large pot of this size, you will have a tax free lump sum over £250K. The question is what to do with it? ( apart from the already mentioned potential IHT issue)
The logic would be to reinvest it in similar funds as in the pension. However then you get into issues with capital gains tax and dividend tax, as the funds are no longer tax sheltered. Plus there is some admin involved. You could shift £20K pa into S&S ISA's (£40K if you have a partner) and eventually the problem will solve itself over a number of years.

honeststeveo

tiring33 said:

honeststeveo said:

Thanks for all of your responses.

OK so to clarify my question, if you watch James' video at this point he says "if you kept the balance below the LTA then no tax would be due" - This vs everything else I have read is the source of my confusion - Can someone explain therefore why in this video it seems to be about the balance rather than the amount that has been crystalised?

I've watched this video from start to finish a couple of times but still can't fathom this.

What you're missing is that, at the point of the video you linked above, James Shack is talking about the LTA test at 75 where your crystallised drawdown pot will be tested against it's value when it was first crystallised.

Unfortunately the LTA test at 75 doesn't just test uncrystallised funds, it also tests any growth in your crystallised funds.

For this reason James is correctly pointing out that you can't just forget about your crystallised funds once they have moved into your drawdown pot, you should ensure that you withdraw enough from your crystallised pot prior to your 75th birthday so that you don't get hit with a 2nd LTA charge on the amount these crystallised funds have grown.

For most people this shouldn't be a problem as they will be withdrawing money from their drawdown/crystallised funds to spend in retirement. It should really only effect those people with very large crystallised pots who struggle to withdraw the growth during their pre 75 years and frankly anyone in that position can probably afford to pay a little extra in LTA charges.

Sorry if this sounds complicated, it just is. The LTA is fairly straight forward once you get your head around it, but unfortunately that can take quite a bit of research. To be fair to James Shack he clearly understands it and has done a good job with his diagrams, but it just isn't that easy to explain.

As far as your strategy is concerned it sounds sane enough to me, but it really depends on your circumstances. Get to retirement age with a pension pot at exactly your LTA, crystallise the lot, take your tax free cash and head off into retirement. You then just need to ensure that, by the time you reach 75, you've withdrawn enough from your drawdown pot that it is not more than the amount you originally put into drawdown, if it is you will pay an LTA charge on the amount it has grown (as you will have used 100% of your LTA when you originally crystallised).

Whether you want to follow the above plan depends on your circumstances. Crystallising your full pot means taking all of your tax free cash which is then inside your estate. Die the next day and the government will take 40% Inheritance Tax from it, keep it in your pension and it can bypass IHT. Or maybe IHT isn't an issue for you (below IHT threshold, no dependents etc.) - as I said, depends on your circumstances.

Thank you so much for explaining! Ok I see effectively the Lifetime allowance which sounds like it might be a single test is actually a series of tests (multiple opportunities for the taxman to dip his grubby hands in..)

I'm visualising it as a series of limbo bars to get under if you don't want to knock your head off :-)

The thing i find counter intuitive is it seems like the first "event" tests the total crystalised (ie candidate for widrrawal) but the second test seems to ignore the money that the pension has already paid out.

So in essence you could get say 1.5M from a pension it it were 1.05M when you crystalised in full at say 65 and then have it pay you 450K over 10 years and you wouldn't have to pay any LTA tax even though 1.5M >> 1.073M ....

tiring33

honeststeveo said:

So in essence you could get say 1.5M from a pension it it were 1.05M when you crystallised in full at say 65 and then have it pay you 450K over 10 years and you wouldn't have to pay any LTA tax even though 1.5M >> 1.073M ....

That is true. Of course the £450k you take out over 10 years will be subject to income tax. The tax man is encouraging you to use it rather than just having it sit there - that way they get their slice earlier!