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Don’t Get a Nasty 75th Birthday Surprise

Martin Tilley looks at The Lifetime Allowance and why pension savers need to plan ahead to avoid sleepwalking into an unexpected tax liability.

Prior to the budget of 2014, conventional wisdom was to draw down on your pension fund, reducing it as much as possible to avoid the consequences of purchasing an annuity, or suffering the taxation on funds remaining on death. The pension freedoms of 2015 changed that through the introduction of more flexible pension payments and by widening the scope of beneficiaries to whom the passing of undrawn funds could be made free of IHT.

At a stroke, for many it became more beneficial to draw down on personal investments including ISAs, thus reducing the value of the taxable estate (on death) and leaving the pension capital untouched. Where income is required from a pension fund the flexibility offers plenty of scope for legitimate income tax planning.

These are sound strategies with the expectation of a pension fund increasing in value over time. For those whose pension pots fall well below the Lifetime Allowance, this is unlikely to be an issue, but for some, a nasty sting could be waiting in the tail. This is because an individual’s pension is not just tested against the Lifetime Allowance (LTA) on the date benefits are drawn: they are also retested again, on movement between income drawdown and annuity and on reaching age 75 (see below).

These tests assess the value of an individual’s fund at the appointed date, less the value of the fund that was placed into drawdown (after taking the tax-free lump sum). Any increase in value is tested against the individual’s remaining LTA. If there is insufficient available Lifetime Allowance, part of that increase will be taxable as a Lifetime Allowance Tax Charge which could be at a rate of up to 55%.

Example – Alison (Age 65)

Alison has previously elected for Fixed Lifetime Allowance of £1.25m. She has a pension fund valued at £1.125m at age 65 which represents 90% of her LTA. She draws on her entire fund receiving a tax-free cash sum of £281,250 and the balance of £843,750 resides in her income drawdown fund.

Alison does not need an income from her pension as immediate income needs are met from personal investments; she wants to leave an IHT-free legacy to her children and grandchildren. Her income drawdown fund remains invested. At Age 75 and assuming a compound return of just 3%p.a. for 10 years, the fund value would have risen to £1.134m, an increase of £290,250.

Her 75th birthday will trigger a Lifetime Allowance test.  Remember that Alison had only 10% of her LTA remaining (£125,000).  Therefore, the excess of £165,250 will be subject to the Lifetime Allowance Tax Charge. There are no further LTA tests post age 75.

When does this liability have to be paid? If Alison elects to take the £165,250 as a lump sum the tax charge is 55%, or £90,887.50. If she leaves the fund untouched, there is a tax charge of 25% or £41,312.50. Whichever applies, the tax due would become immediately payable by the pension fund. Income Tax may also be payable on any subsequent withdrawals (from the remaining fund), either by Alison or her beneficiaries after her death, depending on their tax position.

With this knowledge it may have been more prudent for Alison to have used a combination of personal investment income and pension income drawdown, as part of a coordinated strategy of gifting away to her heirs.

The example highlights how important it is for clients to have a close relationship with their adviser, and for advisers to proactively identify future issues even though they may (as is the case here) be ten years’ away.

To find out more on this subject visit www.hurleypartners.co.uk or contact Martin Tilley on 020 8936 3970 or Martin Collins on 0161 376 7579.

Hurley Partners strongly recommends that individuals should seek suitable professional advice regarding the matters referred to in this document, which has been prepared for general interest only. Nothing in this document constitutes advice. Hurley Partners Limited is authorised and regulated by the Financial Conduct Authority. Registered in England and Wales No. 8401891. Registered Office; 12 Conduit Street, Mayfair, London, W1S 2XH. © Hurley Partners Limited 2020