75 in sight?

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.

The background

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.

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:

1. Accessing your (tax-free) lump sum before or at 75– BCE 6
2. Taking an income before or /deemed to be taking an income at 75 – BCEs 1, 2, 3, 4, 5, 5A, 5B,
3. 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 6^th 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):

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:

1. Uncrystallised money purchase funds (BCE 5B)
2. Uncrystallised defined benefits (BCE 5)
3. 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.

Summary

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.