Exceeding LTA after Entering Drawdown

gf1966 · 17 June 2018 at 1:51PM

I have a question about the LTA

At age 55 someone has a pension worth £1m (below LTA) and they enter drawdown, keep it all invested but start taking a monthly income. Over the next few year the investments grows and exceeds the LTA.

When would they start incurring the additional tax charges for exceeding the LTA?

I know it gets re-tested again at age 75, but does it also get tested each month when the income is drawn?

Would they pay additional tax for each month their fund is above the LTA or do they only incur the additional tax after they’ve withdrawn income up to the LTA?

Thanks in advance!

peterg1965 · 17 June 2018 at 1:55PM

My understanding is that the LTA is measured at the crystallisation of the pension. If its below the LTA, then the drawdown element of the pension is free to grow without any additional tax charge (other than the income tax payable on taking money out). It is not then tested against the LTA until age 75, it is at that point that additional LTA tax charge is levied.

zagfles · 17 June 2018 at 2:07PM

The LTA gets tested at Benefit Crystallisation Events. Google LTA BCE to gets lots of helpful articles.

If you crystallise the whole lot, that's it till 75. If you take monthly UFPLS's, it'll get tested every month. If you phase drawdown, it'll get tested every time you move a new chunk into drawdown.

gf1966 · 17 June 2018 at 3:05PM

Thanks for your swift replies. That's really helpful.

So if I've understood this correctly. entering drawdown with a pension which is just below the LTA will effectively protect it's growth from the LTA until you're 75 or hit some other Benefit Crystallisation Events.

At age 75 it sounds like it would make sense for many people in such a situation to withdraw more from the fund before it is tested again. Does that sound right?

EdSwippet · 17 June 2018 at 3:19PM

gf1966 wrote: »

At age 75 it sounds like it would make sense for many people in such a situation to withdraw more from the fund before it is tested again. Does that sound right?

Yes. From this Scottish Widows paper:

As drawdown becomes more popular more clients will be subject to the second LTA test. However, with careful planning it should be possible to avoid a LTA charge in most cases.
...
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.

Alibert · 17 June 2018 at 6:42PM

I have been thinking a lot about this - and it's problematic , and will require a lot of management.

If you have exceeded the LTA when you reach 55 then the general strategy is to crystallise it into drawdown (ie create a £1m SIPP) and then over the next twenty years withdraw ALL further growth before you reach 75.

Which is quite problematic
- with any reasonable inflation expectation a £1m pot in twenty years time will be worth half what it is now. That's not an attractive plan
- (although the LTA is index linked , that doesn't help you as you have used 100% of it when you are 55, so any further rises in the LTA don't apply to you
- and when do you take income -- let's say you are not intending to retire until 65, so are earning money. This means that any withdrawals from 55-65 will be taxed at your full marginal rate. Likey 40% if you have managed to build up a £1m pot by 55.

basically the Law drives you into some less-than-sensible pension planning decisions that look to have quite negative impact on your retirements

gf1966 · 18 June 2018 at 1:13PM

I was a bit confused by your comment:

"although the LTA is index linked , that doesn't help you as you have used 100% of it when you are 55, so any further rises in the LTA don't apply to you"

At age 75 wouldn't you be re-tested against the new inflation adjusted LTA?

Alibert · 18 June 2018 at 1:32PM

Nope.
If you use (say) 60% of the LTA now , then at 75 you would be tested against 40% of the new larger LTA

If you use 100% of your LTA now , then that's it, you have 0% left.

bearshare · 18 June 2018 at 4:24PM

Crikey, thanks Alibert. I had not twigged that. Requires some thought indeed. I had assumed the best strategy was to maximise growth in the SIPP until close to LTA, then crystalise the lot.

What happens if you have 2016 protection of £1.25m, and crystalise at £1m? You have only taken 80% of your LTA, but the £1.25 is not indexed.

B

Alibert · 18 June 2018 at 9:04PM

bearshare wrote: »

Crikey, thanks Alibert. I had not twigged that. Requires some thought indeed. I had assumed the best strategy was to maximise growth in the SIPP until close to LTA, then crystalise the lot.

What happens if you have 2016 protection of £1.25m, and crystalise at £1m? You have only taken 80% of your LTA, but the £1.25 is not indexed.

B

1 - I think that is the best strategy. But welcome other views
2 -
you have left 20% of your LTA (250k) unused until the next time you crystallise
the way I understand it, if/when the default LTA (£1.03m) grows to exceed your LTA of 1.25, from then on you'll enjoy an LTA of 20% * the default.

Exceeding LTA after Entering Drawdown

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