75 in sight?
It's time to start thinking about the Lifetime Allowance...
16 January 2023
Pension considerations in the years running up to age 75
Age 75 has become a complicated and convoluted fulcrum within pension related planning. It can be a problematic (and sometimes expensive) milestone which is best reviewed several years in advance. To avoid this becoming an overly technical tome, below I’ve summarised some of the key considerations. I apologise now for the use of jargon but, frankly, with this subject it comes with the territory.
Back in April 2006, the gloriously named but oxymoronic ‘pension simplification’ regime came into being. Part of the new regime introduced the concept of the Lifetime Allowance – with various protection schemes in place for those with large, accrued pension values and for those already in receipt of some/all their pension. Various schemes have been introduced over the years for those with larger pension pots in line with legislative changes but, for brevity, these are not within scope here.
The Lifetime Allowance
The Lifetime Allowance (LTA) is the limit applied to your accrued pension benefits before an excess charge is applied. This limit doesn’t prevent additional accrual or asset growth, it simply applies a penalty if your pension is above the limit at the time you take pension benefits. The level of the LTA has been tinkered with frequently by successive Chancellors – an easy target during the ‘Austerity Years’ to stealth tax pension ‘millionaires’ without media backlash. The current standard LTA is £1,073,100 and has been frozen at this level until at least April 2026 (in reality, reduced significantly in real terms by inflation), and is now demonstrably lower than when first introduced in 2006/07 at £1.5m. Therefore, if you have any form of pension protection, it is vitally important to understand its parameters, limitations and how it could be inadvertently lost!
Lifetime Allowance tests
When you access previously untouched benefits from a pension scheme, for example taking tax free cash or drawing an income, this is known as a benefit crystallisation event (BCE) and your accrued pension is tested against the LTA. The amount ‘crystallised’ will use up some, or all, of your LTA, unless your full LTA has already been exhausted – at which point any excess is subject to a charge.
A percentage figure is typically used to express the amount of standard LTA used. As you can choose to crystallise benefits on multiple occasions, so the percentages used are added together at each BCE to check if your LTA has been exceeded. If the cumulative percentage exceeds 100% at a BCE, the amount crystallised above your available allowance is subject to the LTA excess charge. If you have protection in place, the rules are slightly different, and you should seek advice.
Lifetime Allowance Excess Charge
The legislation makes clear the charge is most definitely not a ‘tax’. It’s a ‘charge’ that simply has all the attributes of a tax… only the amount above the limit is subject to the charge.
There are two rates applicable to the LTA charge, and the rate that applies depends on how the excess is paid:
- Lifetime Allowance Excess Lump Sum
- An immediate charge of 55% is applied to the excess, in practice, deducted by the pension provider and remitted to HMRC on your behalf.
- You are required to add the excess charge information on your self-assessment.
- This route is not an option at age 75.
- Lifetime Allowance Excess Income
- An immediate charge of 25% is applied to the excess, in practice, deducted by the pension provider and remitted to HMRC on your behalf.
- You are required to add the excess charge information on your self-assessment
- Option to draw an income (or not) from the residual pot, but any income drawn is paid via PAYE at your marginal rate.
- Tax beneficial for a basic rate taxpayer – 40% overall
- Tax neutral for higher rate taxpayer – 55% overall
- Tax disadvantageous for additional rate taxpayer – 58.75% overall
Lifetime Allowance Tests approaching age 75
Currently there are 13 different BCEs – some incredibly specific, others unusually broad, some very common, others, as rare as hen’s teeth. The type of pension you are accessing will determine which BCE is applied and, often, more than one BCE is applied concurrently.
For the purposes of this piece, there are perhaps three overarching themes for the tests that need to be considered as you approach 75:
- Accessing your (tax-free) lump sum before or at 75– BCE 6
- Taking an income before or /deemed to be taking an income at 75 – BCEs 1, 2, 3, 4, 5, 5A, 5B,
- Death before 75 – BCEs 5C, 5D, 7
It should be noted that ‘doing nothing’ will still result in BCE tests being applied at 75. The different BCE numbers deal with different scenarios and pension types: for example, defined benefit (final salary) or money purchase (personal pensions); or how your pension assets are distributed to your beneficiaries on your death.
Post 75, there is only one potential test (BCE 3), and this is only triggered if the amount being paid by a defined benefit scheme (scheme pension) increases above a certain level, typically the higher of 5%, RPI or £250.
Pensions in payment pre 6th April 2006
If these are the only pensions you have, congratulations, they will never be considered for LTA purposes. If, however, you had pensions in payment before April 2006, and still have uncrystallised pension benefits, your pre-2006 pensions will be taken into account when future BCE tests are applied. This is quite a nuanced area and requires specialist advice.
How benefits are tested against the LTA
The amount of LTA used up at a crystallisation event depends on the type of benefit being paid. The main benefit lifetime types are valued as follows (I’ve dealt with death benefits separately):
|Benefit Type||Valuation for Lifetime Allowance benefit crystallisation|
|Tax free cash||Amount of the lump sum|
|Scheme Pension (final salary)||20 x initial annual rate of pension income|
|Annuity||Amount of fund used to purchase the annuity|
|Income Drawdown||Amount of fund designed into drawdown|
It should be noted that the BCE tests are often concurrent e.g., tax free cash and designation to drawdown.
By taking all/some of your tax-free cash, this typically means that you become entitled to an income too. If that income is to be provided by way of ‘drawdown’, then there is no actual need to draw any income from the newly crystallised pot, allowing you to control your income tax position; however, as can be seen below, this can have adverse consequences at age 75 if not managed proactively.
Upon reaching Age 75
Whilst you can access your accrued pension benefits ahead of time, if uncrystallised, age 75 becomes a cut-off point and three possible tests occur:
- Uncrystallised money purchase funds (BCE 5B)
- Uncrystallised defined benefits (BCE 5)
- A second test on drawdown funds
If you reach 75 with uncrystallised pension funds, these will be tested against your available LTA. If there is insufficient LTA remaining, then the excess will be charged at 25% (the 55% charge is not an option at age 75).
- Uncrystallised money purchase funds BCE 5B
If you reach 75 with uncrystallised money purchase funds, typically personal pension or SIPP, the crystallised value is the market value of the fund at that date.
The funds don’t have to be designated for income drawdown or annuity purchase at age 75 but can be left as ‘unused funds’. These funds are tested against the LTA and, even though benefits aren’t necessarily going to come into payment, an LTA charge could arise.
Whilst there is no requirement for you to actually withdraw either your tax-free cash or an income from your pension, there can be advantages to drawing your tax-free cash at this point, as on death (post 75) it moves from tax free to taxable.
- Uncrystallised defined benefits BCE 5
If you reach age 75 with uncrystallised scheme pension and lump sum benefits from a defined benefit scheme, the crystallised value is 20 x the yearly scheme pension, plus the amount of any separate tax-free cash payable.
If tax free cash can only be taken by commuting part of the pension, the crystallised value of the benefits is simply 20 x the yearly scheme pension before commutation.
- Second test on drawdown funds BCE 5A
A second test is applied when your drawdown pension fund reaches age 75.
The crystallised value is the market value of your drawdown fund at 75 less the amount originally moved into income drawdown at the outset (i.e. after the payment of any tax free cash). The reason for this deduction is to reflect that these funds have effectively already been tested for LTA purposes when the funds were originally designated to provide drawdown.
In simpler terms, you are essentially tested on the growth of the capital value since you went into drawdown, with reference to any residual LTA you have. If there is no growth, or any growth is within your remaining LTA, no charge is applied.
Lifetime Allowance and death before age 75
There are three BCEs that can happen on your death, but these are only tested if you die before age 75.
If your accrued pension benefits are below the LTA, then typically all can be paid out tax free – regardless of the route chosen.
Death benefits from pensions already in payment won’t use up any LTA, including the balance paid from a fund in drawdown; however, the following can all be included, which can cause issues and take you inadvertently above the LTA if not addressed:
- uncrystallised money purchase funds;
- the value of any pension term assurance;
- company death in service arrangements (scheme dependent);
- lump sums from defined benefit arrangements are tested when paid out within two years of the member’s death.
Uncrystallised money purchase funds can be paid out in two different ways, either as a lump sum to your nominated beneficiaries or as a pension. The pension route has some interesting options – it could be as an annuity to provide a secure income for a surviving spouse or income drawdown to offer greater flexibility. This route can also be used to cascade wealth down the generations (and can be left to accumulate longer term e.g. to grandchildren).
These death benefits will be tested against your LTA and the amount used will be the amount of lump sum paid, the amount designated for drawdown, and/or the purchase price of the annuity.
Defined benefit schemes can cause havoc with any LTA planning. If these pay out lump sums on death, either as part of the existing retirement benefit scheme or a separate ‘death in service’ scheme, the value of the pay-out is the amount tested against the LTA. Given that Death in Service arrangements are typically based upon a multiple of salary, when added to accumulated pension benefits, this can mean that the expected payment on death becomes subject to the LTA – this can get very messy and is often avoidable.
Lifetime Allowance and death post age 75
There are no BCEs on death after 75; however, whereas any pension benefits within the LTA are generally payable tax-free pre-75, death post 75 results in all benefits being taxed upon the recipient’s marginal rate of income tax at the point it is drawn. This can offer some interesting planning opportunities – both to provide for any surviving spouse, but also for inter-generational wealth planning.
Liability for the excess charge on your death
Unlike during your lifetime, if an LTA charge arises on your death, the liability to pay the charge falls on the recipient(s) of the benefits, rather than on the scheme administrator.
The scheme administrator will pay benefits in full and it’s your personal representatives who are responsible for establishing if a chargeable amount has arisen. If it has, they have to report this to HMRC, who will then assess the beneficiaries.
Where there are multiple beneficiaries, any LTA tax charge liability will be apportioned between the beneficiaries on a ‘just and reasonable’ basis, as determined by HMRC.
Within this piece, I’ve tried to address some of the key considerations; however, if you are potentially affected – it really is best to review your options in advance.
All authors have considerable industry expertise and specific knowledge on any given topic. All pieces are reviewed by an additional qualified financial specialist to ensure objectivity and accuracy to the best of our ability. All reviewer’s qualifications are from leading industry bodies. Where possible we use primary sources to support our work. These can include white papers, government sources and data, original reports and interviews or articles from other industry experts. We also reference research from other reputable financial planning and investment management firms where appropriate.
Saltus Financial Planning Ltd is authorised and regulated by the Financial Conduct Authority. Information is correct to the best of our understanding as at the date of publication. Nothing within this content is intended as, or can be relied upon, as financial advice. Capital is at risk. You may get back less than you invested. Tax rules may change and the value of tax reliefs depends on your individual circumstances.
Find out more about our award-winning wealth management services…
Financial Advisory Firm of the Year
Client Relationships Award
Financial Services, Banking and Insurance Firm of the Year
Investment Performance Cautious Portfolios
Best Medium Firm
Investment Performance: Cautious Portfolios
Investment Performance: Balanced Portfolios
Financial Planning Firm of the Year: Small to Medium Firm
Financial planning can help you reach your goals in life, whether you want to determine when you can retire comfortably, bring organisation to your financial world or pass on your wealth effectively.
Pensions and retirement planning
Deciding when to retire is a challenging decision and can feel like a leap of faith. At Saltus, we gather information on all of your existing assets and then use our technology and expertise to show you exactly how to achieve the retirement you’re after.
Reducing your tax burden
How to structure your wealth and access income should be approached in a sophisticated way. A detailed financial plan may use pensions, ISAs, general investment accounts, offshore bonds and other tax wrappers to ensure you can draw your money in a tax-efficient manner.
Consolidating your wealth
Holding multiple investment accounts and pensions can mean they’re hard to keep track of and administer. We’ll help you overcome this by consolidating your accounts into a single plan so that you can understand your financial position with ease.
Protecting you and your assets
We protect our cars and houses without much thought yet you might be the most valuable asset in your family. Whatever your situation, we can provide advice to ensure you have the right level of insurance in place to keep your finances protected.
Passing on your wealth
Estate planning is more important than just having a Will. We’ll work closely with you to understand how estate planning, which has emotional as well as financial consequences, can impact your overall financial plan.
Significant life events
Significant life events can present great opportunities but also considerable challenges. Whether you are going through a business sale, divorce or are receiving a lump sum, we’ll help build a financial plan to meet your changing lifestyle.