Initial information on LTA issues

[jtr63]

Due to a generous employer pension and some significant gains on shares within my SIPP portfolio, at current rates of performance I expect to reach my LTA limit within about 12 months. I am 57 and expect to work for 3 to 5 years more. Can board contributors recommend sources of information that will enable me to understand LTA issues a little better than I do at the moment, and also begin to consider what, if any, steps I should be considering to mitigate against excessive tax liabilities. (I accept that there will be some.)
TIA
John

[ursaminortaur]

Due to a generous employer pension and some significant gains on shares within my SIPP portfolio, at current rates of performance I expect to reach my LTA limit within about 12 months. I am 57 and expect to work for 3 to 5 years more. Can board contributors recommend sources of information that will enable me to understand LTA issues a little better than I do at the moment, and also begin to consider what, if any, steps I should be considering to mitigate against excessive tax liabilities. (I accept that there will be some.)
TIA
John

Is the employer pension a DB or a DC scheme ?
If it is a DC scheme will the employer allow partial transfers out to a SIPP ?

If the latter is possible then you might be able to mitigate some of your LTA problems by making use of the small pots legislation either by transferring £10k slots into three different SIPPs or by finding a SIPP provider who will allow you to partion your SIPP pot into a number of different arrangements.

If your employer pension is a DB pension or won't allow you to partially transfer out then you could also look to do this with your existing SIPP if the SIPP provider allows you to split it into multiple arrangements of £10k or you can find a provider which does so that you could transfer to them.

https://www.pruadviser.co.uk/knowledge-literature/knowledge-library/small-pots-and-triv-qna/

Q. Is there any benefit to receiving a small pot (lump sum) payment instead of an uncrystallised funds pension lump sum (UFPLS)?

A. Small pots do not use, or require the customer to have any available, lifetime allowance (LTA). So, they can be used to avoid LTA excess charges where someone has used all their LTA but has a stranded pot worth up to £10,000. An UFPLS payment is subject to the client having sufficient available LTA before age 75 and at least some remaining LTA on or after age 75.

Small pots do not trigger the money purchase annual allowance (MPAA). An UFPLS payment of any amount does trigger the MPAA.
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Q. My client has a small SIPP worth £24,000. Can he take this as three small pots?

A. This may be possible depending on the provider who holds the arrangement. They may be able to separate this into multiple arrangements. Be careful though if your client holds enhanced or any of the fixed protections (2012, 2014 or 2016) as setting up a new arrangement for this purpose would lose these forms of LTA protection.

This answer relates to non-occupational pension schemes only, as one of the conditions for a small lump sum payment is that each payment of up to £10,000 must extinguish the member’s rights under the arrangement making the payment.

This is fundamentally different from the condition for a small pot payment from an occupational pension scheme which must extinguish the member’s rights to benefits under the paying scheme.

Secondly since you are over 55 you could crystallise the existing SIPP by taking the 25% tax free lump sum. This will use up a percentage of your LTA limit but future drawdowns will not cause any further LTA tests. There will be a final LTA test at age 75 but that just looks at the growth which has occurred between crystallisation and age 75 which still remains in the pot. Hence this age 75 test can be rendered toothless by taking out all the growth sometime before you reach 75 years of age. Note. Do not take any drawdowns from this crystallised pot beyond the tax free lump sum until you have finished working since doing so would trigger the MPAA and limit your contributions to your occupational penson to £4000 per year if it is a DC pension. (The MPAA doesn't restrict future contributions to a DB pension so you might be OK to trigger it if that is what your occupational pension is).

https://www.thepfs.org/news-insight/news/articles/drawdown-planning-and-the-lifetime-allowance-tests/94262

As there are no longer any limits on the income the client can take in drawdown, there is the option to control how much is subject to the second LTA test at age 75. Income levels can be increased to reduce the fund value; however, any income will of course be subject to income tax. In addition, this may increase the value of the estate for IHT purposes if the income is not required.


https://www.pruadviser.co.uk/knowledge-literature/knowledge-library/money-purchase-annual-allowance-mpaa/


If you do exceed the LTA limit then you can choose to take the excess either as a tax free lump sum in which case a LTA excess charge of 55% will be applied to the excess or you can take it as income in which case a 25% LTA excess charge will be applied to the excess but drawdowns of tha excess like the rest of your pot will be taxed at your marginal rate. If your marginal rate is 40% then that in combination with the 25% excess charge will be the same as the 55% charge which would have been applied if you had taken it as a tax free lump sum.
(The option to take the excess as a tax free lump sum is only available before you reach age 75 - after the age 75 LTA test you can only take the excess as income).

https://adviser.royallondon.com/technical-central/pensions/benefit-options/lifetime-allowance-charge/

Hope this is of some help.

[Kantwebefriends]

"at current rates of performance I expect ..."

Just wait for the market crash.

[Dod101]

"at current rates of performance I expect ..."

Just wait for the market crash.

Kantwebefriends may sound cynical but ' the best laid schemes o' mice and men' may mean that you have nothing to worry about. Worry about it at the time, not now. Current performance will not continue. It might be worse or it might be better.

Dod

[TedSwippet]

Secondly since you are over 55 you could crystallise the existing SIPP by taking the 25% tax free lump sum. This will use up a percentage of your LTA limit ...

That is what I would considering doing in this position. Reasoning is as follows.

Currently, you are a little below the LTA, so you have a chunk of LTA 'headroom' -- that is, an amount by which your pension(s) is/are below the LTA at present. Two things can consume that headroom: growth in the assets within the pension; and new contributions. If you do nothing, when you exceed the LTA you will pay a 25% penalty on withdrawals above it. This takes the effective tax rate on these parts of the withdrawal to 40% (basic rate) and 55% (higher rate).

These rates are higher than you would pay on unwrapped investments, and are probably equivalent to or higher than, or at best the same as, what you pay on ordinary income. So, above the LTA a pension is a tax ball-and-chain rather than a tax shelter.

How best to utilise this remaining LTA headroom, then? If you plan to give up work now (and hitting the LTA is certainly motivation to do so), then leaving your SIPP to grow to exactly the LTA then crystallising all of it gets you the best PCLS. If planning to work and make more pension contributions though, as you've indicated, then crystallising your pension now would prevent growth in the assets consuming the headroom, and this means that you have more space for future pension contributions. Depending on your marginal tax rate, this could be a highly useful benefit.

Crystallising what you have now means you have to find a home for the 25% PCLS. The ideal is to funnel this into ISAs as fast as possible, but this can't be done quickly. Otherwise, investing it outside the SIPP but in the precise same assets as it was inside still makes sense. The separate dividend and capital gains allowances should help mitigate tax on these unwrapped investments. Also, if you're a passive investor then that too will help minimise (at least ongoing) capital gains tax. And if you're married, you might be able to use your spouse's ISA allowance and other allowances to further reduce the tax on gains that these assets spin off.

The TL;DR here, if there is one, is that optimising the LTA creates a tricky balancing act, requiring you to project and model estimates of future market growth, LTA changes (including government caprice), your own salary and total income (including investment income), future income tax rates (again including government caprice), and so on.

... the best laid schemes o' mice and men' may mean that you have nothing to worry about. Worry about it at the time, not now. Current performance will not continue. It might be worse or it might be better.

Respectfully disagree. If you do nothing and performance is worse then you can make up the shortfall to the LTA either by waiting for a recovery or with new pension contributions. If you act and performance is worse you can still make up the shortfall with new pension contributions. If you do nothing and performance is the same or better though, you would have been better off acting. Worrying about it "at the time" is not particularly sensible, since at that point it is too late to mitigate.

[hiriskpaul]

Agree with TedSwippet. Worrying about it "at the time" is not sensible as it means you are limiting your options.

If you have a DB scheme you need to decide whether to take that first or crystallise the SIPP first. Not an easy decision for someone who is likely to exceed the LTA. Reduced indexed linked pension or reduced PCLS and drawdown SIPP? There is no clear cut answer as it depends on one's attitude to risk, legacy preferences, etc.

Another complicating factor is the inheritance tax saving feature of the SIPP. How valuable is that to you? If the answer is "a lot" and you are a higher or additional rate taxpayer, then continuing to make maximum SIPP contributions might be a good thing to do, even if that results in a higher LTA charge.

Opting out of your employers scheme is another option. Seldom a good one though.

There are typically no easy answers to this problem, but it is well worth understanding the issues and deciding on a plan.