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If only Victor Meldrew had planned his retirement income before he became a grumpy old man, with one foot in the grave! By Julie Sebastianelli, Wealth Management Director at Mattioli Woods
I DON’T BELIEVE IT!
When you have spent a lifetime dreaming of enjoying your retirement, safe in the knowledge you have enough put aside in your pension, the last thing you want is to be hit with an unexpected tax charge as you turn age 75. Never rest on your laurels; changes happen and sleepwalking through them might cost you dear.
❛❛ Never rest on your laurels; changes happen and sleepwalking through them might cost you dear ❜❜
In 2015, new pension ‘freedom rules’ provided greater fl exibility in terms of payment and accessibility. At the same time, there was a widening of the scope of benefi ciaries to whom the passing of undrawn funds could be made free of inheritance tax (IHT).
The favourable IHT position pensions enjoy has seen an increase in clients using their personal wealth to fund their lifestyle, and to reduce their taxable estate on death. In this scenario, clients prefer to view their personal pension pots as ‘next generation’ monies.
❛❛ You need to be mindful you are not caught by a lifetime allowance (LTA) tax charge ❜❜
However, you need to be mindful you are not caught by a lifetime allowance (LTA) tax charge. The LTA is the total amount you can build up in all your pension savings without incurring a tax charge. Any excess could be taxed at 25% and potentially up to 55%. The standard allowance for the current tax year (and until April 2026) is £1,073,100.
You will not use any of your LTA until you start taking benefits from your pension arrangements. When this happens, it is known as a benefit crystallisation event (BCE) and at each event your pension is tested against the LTA to see whether an LTA tax charge is due. All final salary and money purchase pensions are included.
At age 75, money purchase pensions are tested again against their LTA, whether they have been crystallised or not, creating a nasty surprise for some.
It is possible to maintain the LTA at a higher level through one of the protections that have been available. This is still an essential planning tool for individuals who have, or may have, pension savings in excess of the LTA. There are two LTA protections currently still available: fixed protection 2016 (FP16) and individual protection 2016 (IP16). Each type protects the LTA at or up to £1.25 million but with different considerations and conditions. This is where expert advice can be most valuable.
Protecting the LTA does not mean you can avoid the LTA charge, as any BCE at a time when the fund is over the appropriate LTA limit will trigger a tax charge.
THE CASE OF MR AFFLECK
On April 5th 2016, Mr Affleck’s pension was valued at £1.2 million and he was aged 68. He did not protect the pension benefits he had accumulated as the LTA at the time was £1.25m. He took tax free cash of £300,000 leaving a fund of £900,000 and decided to draw no income. As time has gone on the Government reduced the LTA to £1 million on April 6th 2016, later increasing it by RPI annually until it was frozen in 2021 at £1,073,100.
Accessing his pension triggered an LTA test against the £1.2 million. This used up 96% of his allowance. Any further growth that causes the fund to exceed the remaining 4% at the next crystallisation event will then be subject to the LTA tax charge.
By May 2022, Mr Affleck has taken no pension income. He is 75 in May 2022, which means his pension will be tested against the LTA for the last time.
The £900,000 he had left in his pension has now grown to £1,050,000. The increase of £150,000 has to be tested against the current LTA of £1,073,100. With only 4% of the LTA remaining, there is now an excess of £106,773. This excess will now attract an immediate 25% tax charge of £26,693. The liability becomes immediately payable by the pension fund.
If Mr Affleck draws some of these excess funds from his pension in the future, he will be subject to income tax at his marginal rate. The same applies after his death when his beneficiaries draw from their inherited ‘designated fund’.
The above example shows how important advice is, as pensions now have greater flexibility and with that comes greater choices for individuals. It is not a straightforward decision to leave the pension untouched in the knowledge that an LTA charge may be lurking. At Mattioli Woods, we can help you with your retirement plans. Even though retirement may be some years away it is never too early to plan. Then you may not have to utter those words ‘I don’t bel… !’
