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Tax on exceeding Lifetime Allowance

MyNameIsUrl
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Tax on exceeding Lifetime Allowance

#427708

Postby MyNameIsUrl » July 14th, 2021, 5:07 pm

My understanding is that to calculate an LTA test today I would simply add the value of my sipp to 20 times my gross DB pension. But would the lump sum paid at the start of my DB pension in 2003 also be taken into account?

I’m aware of the dangers of letting the tax tail wag the dog, but I am considering whether taking the maximum tax-free lump sum soon would be advantageous (or not):
If I leave the sipp untouched until age 75, then the LTA test carried out at that point would be, making some assumptions about growth of DB pension and sipp, about £160k above the limit. Is my tax bill therefore 25% of that, ie £40k?
However, withdrawing from the sipp would expose the money to 20% (or 40%) income tax (beyond the tax-free amount), and possibly all of it to a further 40% inheritance tax. If I understand correctly and the ‘do nothing’ option is capped at £40k it could be in the long run be better than crystallising earlier. Is my understanding correct?

ursaminortaur
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Re: Tax on exceeding Lifetime Allowance

#427727

Postby ursaminortaur » July 14th, 2021, 6:43 pm

MyNameIsUrl wrote:My understanding is that to calculate an LTA test today I would simply add the value of my sipp to 20 times my gross DB pension. But would the lump sum paid at the start of my DB pension in 2003 also be taken into account?


The DB calculation is

20 x (initial annual DB pension + tax free lump sum taken) for any defined benefit pension taken after A-day in 2006.

However, from the above, it would seem that this DB pension was taken in 2003 and hence different rules apply.
There would have been no LTA test in 2003 but if you now access another pension eg your SIPP then the pre-2006 DB pension will now be tested.

The DB calculation will be

25 x the current annual DB pension

No reference is apparently made to the tax free lump sum that was taken instead that is covered by the increased multiple of 25 rather than 20 being used.

See the following example

https://adviser.royallondon.com/technical-central/pensions/case-studies/lifetime-allowance---how-benefits-are-tested/

Aaron is 64, married to Amy. They have a grown-up son who does not live at home. Aaron plans to retire when he is 65.

He has 3 pension arrangements:

A pension from his 22 years in the forces, which he started to draw in 1994, when he received a lump sum of £24,650 and a pension of £7,350 a year, which has increased to its current rate of £11,905 a year.
He will have 26 years’ service with a major security company where he is a head of department at age 64. His defined benefit scheme is a 1/60th scheme with a normal retirement date of 65 and his pensionable salary is £69,500. He pays 6% of pensionable salary towards his scheme.
Aaron also has a personal pension which has recently been valued at £250,000.

When he reaches age 65, he will start to take his defined benefit scheme pension benefits with the security company.
How much lifetime allowance will he use?

All examples of benefit crystallisation events in this case study use £1,073,100 as the lifetime allowance, but normally you’d use the current lifetime allowance.

Taking this defined benefit scheme pension will be a benefit crystallisation event, so a lifetime allowance calculation must be done. Pension benefits in payment before 6 April 2006 (also known as pre-commencement or pre A-Day pensions) were not subject to a lifetime allowance check, but if he takes further benefits on or after 6 April 2006, the benefits already taken are also counted towards the lifetime allowance used. This is calculated immediately before the first benefit crystallisation event on or after 6 April 2006 and so reduces the member’s amount of lifetime allowance available for the first benefit crystallisation event.

HMRC Pension tax manual - PTM088300 The lifetime allowance and the lifetime allowance charge: benefit crystallisation events: pensions in payment on 6 April 2006

The value used depends on what type of pension the pre 6 April 2006 pension is.

We first look at his armed forces pension. If this was the only pension he had, there will be no benefit crystallisation event as it’s a pre 6 April 2006 pension, and as there was no lifetime allowance then there’s no lifetime allowance test, but as soon as he takes his benefits from his defined benefit scheme with the security company it’s a benefit crystallisation event and an lifetime allowance test is carried out.

Note: There will never be a lifetime allowance charge against any pre 6 April 2006 pension as valuing a pre-commencement pension is NOT a benefit crystallisation event.
The pre 6 April 2006 scheme pension is valued at 25 x annual pension amount at the date of the first post 6 April 2006 benefit crystallisation event. Pre 6 April 2006 pensions are valued at 25 rather than 20 as the individual is expected to have taken a tax-free lump sum when the benefits were taken.

He doesn’t have any lifetime allowance protection, his pre 6 April 2006 scheme pension of £11,905 a year is in payment when he takes the defined benefits scheme pension (the current value at time of crystallisation is used - NOT the value at 6 April 2006). The lifetime allowance at the date of the benefit crystallisation event is also used.

The pre 6 April 2006 pension uses up 25 x £11,905 = £297,625.
To calculate the percentage of the lifetime allowance used up will be £297,625/1,073,1001 = 27.73%. So, he has used up 27.73% (round down for lifetime allowance purposes) of the lifetime allowance.

He will then need to have his defined benefit scheme benefits valued, which will be 20 times plus any tax-free cash, not provided through commutation of pension benefits - benefit crystallisation event 2.

He only wants to take a pension so it will be valued at 26/60 x £69,500 x 20 = £602,333.33.

The percentage of the lifetime allowance will be £602,333.33/£1,073,100 = 56.13%

So, at this point 83.86%, 27.73% plus 56.13%, of his lifetime allowance has been used up. As he has only used up 83.63% of his lifetime allowance there is no lifetime allowance charge.


MyNameIsUrl wrote:I’m aware of the dangers of letting the tax tail wag the dog, but I am considering whether taking the maximum tax-free lump sum soon would be advantageous (or not):
If I leave the sipp untouched until age 75, then the LTA test carried out at that point would be, making some assumptions about growth of DB pension and sipp, about £160k above the limit. Is my tax bill therefore 25% of that, ie £40k?
However, withdrawing from the sipp would expose the money to 20% (or 40%) income tax (beyond the tax-free amount), and possibly all of it to a further 40% inheritance tax. If I understand correctly and the ‘do nothing’ option is capped at £40k it could be in the long run be better than crystallising earlier. Is my understanding correct?


At age 75 there would be a charge of 25% of the excess. However this would when withdrawn be subject to your marginal rate of tax. If your marginal rate of tax was 40% then this would work out as equivalent to 55% tax.

If you left it untouched for your beneficiaries they would also be taxed at their marginal rate when they withdrew it since you would have died after age 75 - the 25% charge for any excess would have already been paid by yourself at age 75 so they wouldn't have to worry about that.

Although a pension is a good way of avoiding IHT there are other alternatives. If you crystallised all the pots early enough you may be able to avoid exceeding the LTA limit at that time (or if that is not possible limiting the amount of excess). The LTA test at age 75 will then only be looking at the growth in your SIPP since crystallisation which still remains in your SIPP. Hence you can avoid falling foul of the age 75 test by withdrawing that growth. You can mitigate IHT by gifting this to your beneficiaries during your lifetime.

The tax free lump sum is capital and could be gifted as a PET (Potentially Exempt Transfer) which would escape IHT if you survived 7 years after the gift.

The taxed drawdowns though are considered to be income hence they could be gifted on a regular basis as gifts out of surplus income. This has the advantage of not requiring you to survive for seven years in order to escape IHT. You do need though to make sure that you document your regular gifting.

https://www.tilney.co.uk/news/how-do-i-make-regular-financial-gifts-from-surplus-income

Note. Gifts whether out of surplus income or as PETs are free of tax.

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Re: Tax on exceeding Lifetime Allowance

#428612

Postby MyNameIsUrl » July 18th, 2021, 9:09 pm

Thanks for a detailed and authoritative answer. It’s led me to do a lot more reading, and a potential way of reducing my tax liability:

Is it possible I may be able to apply for Fixed Protection 2016?

I have a DB pension which started payment in 2003 (when I was 50). I had three DC pensions, now consolidated into two pots by transferring two of them into a sipp (in 2007 and 2014). My last contribution to any of them was in 2008. I think I therefore have no Benefit Crystallisation Events.

From what I’ve read Fixed Protection 2016 may be something I can apply for. Is this something I can do myself? If I wanted to get professional help what should I look for? A Chartered Financial Planner?

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Re: Tax on exceeding Lifetime Allowance

#428645

Postby TedSwippet » July 18th, 2021, 11:39 pm

MyNameIsUrl wrote:From what I’ve read Fixed Protection 2016 may be something I can apply for. Is this something I can do myself?

Easily. About five minutes of effort. The application process for it is trivial, and designed to be easily handled by taxpayers themselves. It's on the same system (Government Gateway) as tax self-assessment.

If you still qualify for Fixed Protection 2016, you should definitely apply for it. Even if it turns out in future that you didn't need it after all, or if you choose to invalidate it later on by making pension contributions in future, there's no downside to taking it, only potential upside.

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Re: Tax on exceeding Lifetime Allowance

#428882

Postby MyNameIsUrl » July 19th, 2021, 8:03 pm

TedSwippet wrote:Easily. About five minutes of effort. The application process for it is trivial, and designed to be easily handled by taxpayers themselves. It's on the same system (Government Gateway) as tax self-assessment.

Thanks. I must admit at first I confused ‘Individual protection 2016’ and ‘Fixed Protection 2016’ and went down a rabbit-hole of trying to work out the value of my pots on 6 April 2016. But now I log on and see there is literally nothing to fill in: just read the declaration and click submit. It worries me a bit when things seem too easy! But I’ve had no events since 2016 so I’ll just have a final read of the Tax Manual before going ahead.

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Re: Tax on exceeding Lifetime Allowance

#429034

Postby TedSwippet » July 20th, 2021, 12:24 pm

MyNameIsUrl wrote:Thanks. I must admit at first I confused ‘Individual protection 2016’ and ‘Fixed Protection 2016’ and went down a rabbit-hole of trying to work out the value of my pots on 6 April 2016. But now I log on and see there is literally nothing to fill in: just read the declaration and click submit. ... But I’ve had no events since 2016 so I’ll just have a final read of the Tax Manual before going ahead.

Yup, that's all there is to it, for FP2016. If by "no events" you mean no pension contributions that would disqualify you from applying, then it sounds like you're good to go.

MyNameIsUrl wrote:I had three DC pensions, now consolidated into two pots by transferring two of them into a sipp (in 2007 and 2014). My last contribution to any of them was in 2008.

Based on your final sentence here, it looks to me like you could have qualified for FP2014 (£1.5mm) and FP2012 (£1.8mm), but the windows for applying for both of these have now firmly shut. Potentially galling, although you project being around £160k above the current LTA, in which case FP2016 seems like it should fully cover you anyway.

Perhaps a bit of an object lesson for others there though. Keep a constant and very close eye indeed on every single government fiddle with pension rules, to avoid being caught on the hop.

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Re: Tax on exceeding Lifetime Allowance

#429043

Postby scrumpyjack » July 20th, 2021, 12:51 pm

TedSwippet wrote:
Perhaps a bit of an object lesson for others there though. Keep a constant and very close eye indeed on every single government fiddle with pension rules, to avoid being caught on the hop.


Quite right. When they introduced the Lifetime Allowance system you could elect for Enhanced Protection in 2006, whereby the LA did not apply as long as you made no more contributions to any pension. I was well under half the limit then but decided to go for Enhanced Protection as I thought they might reduce the limit and anyway inflation and a few good years on the market could push me over. What a good choice! In spite of the GFC and Equitable Life I'm over three times the limit.


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