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The lifetime allowance for pensions

I must be a masochist. Not content with the torture of bringing clarity to the labyrinthine annual allowance, I’ve now undertaken similar self-harm by tackling the lifetime allowance for pensions.

I’ve given it my best shot in the post that follows. If I failed then please feel free to use it as a sleeping aid.

What is the lifetime allowance and why does it exist?

The lifetime allowance is the total value of money you can build up in a pension before you’re hit with a lifetime allowance charge.

The lifetime allowance as of 2019/2020 is £1,055,000.

The lifetime allowance charge

Any amount above the lifetime allowance is called the excess. When that excess is taken back out of your pension, then a charge of:

  • 55% is levied if it is taken as a lump sum.
  • 25% is levied if it is taken as an income.

A quick recap.

When you put money into a pension the government provides tax relief.

For example, if you earn £80,000 a year then you are a 40% tax rate payer. If you put £600 into your pension out of taxed income, the government will also put £200 into your pension and you can claim £200 relief from HMRC. This gives you a total of £400 tax relief.

The underlying principle behind this pension tax relief system is that you defer taxes. You get back the tax you paid today in your pension, but you will later pay tax when you take the money out.1

It’s this principle which motivates the lifetime allowance.

In effect, the Government has decided it isn’t in the business of giving rich people unlimited tax deferral benefits. It therefore created the lifetime allowance, which limits the total amount of tax deferral the Government is willing to give you.

That sounds reasonable, but unfortunately – as with the annual allowance – the words ‘piss up’ and ‘brewery’ are never far away.

More on that later.

History of the lifetime allowance

The lifetime allowance came into existence on 6 April 2006 – a date known to those in the pensions industry as A Day.

A Day is the pension expert’s equivalent to the birth of Christ.

On A Day a huge raft of disparate measures and rules were scrapped with new ‘simplified’ rules coming into force.

More than eight different regimes were boiled down into two: the lifetime allowance and the annual allowance.

The lifetime allowance was initially set at £1.5 million. It crept up to £1.8m in 2010/11 before being drastically cut back down. But it’s not all bad news – from the 2018/19 tax year the lifetime allowance has increased in line with the CPI measure of inflation.

The changing lifetime allowance, in millions per tax year.

Just to complicate matters, each time the lifetime allowance was cut, the government provided protection mechanisms: in 2006, 2012, 2014, and 2016.

These ensured that some of the excess above the lifetime allowance in a person’s pension was protected from the tax charge.

When is the lifetime allowance assessed?

The most important thing to remember about the lifetime allowance is that it is not assessed just because you have a pension pot above £1,055,000.

Rather, the lifetime allowance is assessed at specific points when you interact with your pension.

These are called benefit crystallisation events (which I’m going to call BCEs for short, even though my editor The Investor hates acronyms!)

There are 12 BCEs in total. I’m going to focus on the six main ones (and also the pre-A Day interaction).

The benefit crystallisation events (BCEs)

Let’s run through what these mean:

BCE1 – When defined contribution benefits become available to pay a drawdown pension. The value is calculated as the market value of the assets made available for drawdown.

BCE2 – When you become entitled to a defined benefit pension. The value is tested as broadly 20 times the annual pension.

BCE4 – When you convert a defined contribution pot into a lifetime annuity. The value is calculated at the cost of purchasing the annuity.

BCE5a – When, for a pot in drawdown, the member reaches 75. This is calculated as the value of the drawdown less any amounts previously crystallised under BCE1.

BCE6 – When you receive a lump sum before age 75 (i.e. the tax-free lump sum). This is calculated as the value of the lump sum.

BCE8 – When you transfer out to an overseas pension scheme (called a QROPS). This is calculated as the amount transferred, less any amounts crystallised under BCE1.2

Pre-A Day test – The pots are measured at 25 times pension or max capped drawdown. This is to account for tax-free cash taken. Pre-A Day pots are measured when the 1st post-A Day BCE occurs (such as, reaching 75 (BCE 5a) with a drawdown pot post-A Day).

A word on defined benefit vs defined contribution treatment

What is perhaps noticeable is the disconnect between how defined benefit and defined contribution pots are measured.

Broadly, defined benefit pots (BCE2) are valued at 20 x annual pension whilst defined contribution pots are valued at the annuity purchase price (BCE4) or the drawdown market value (BCE1).

To illustrate:

A £100,000 defined contribution pot could buy a £2,801 joint-life 50%, 3% escalation annuity at age 65.3

This would be valued at £100,000 under BCE4.

However if such an income was provided through a defined benefit pension it would be valued at only £56,020 under BCE2.4

With annuity rates at all-time lows, it is possible that were somebody to transfer from a defined benefit to a defined contribution scheme, they could end up the wrong side of the lifetime allowance and incur a tax charge that they may have avoided if they’d stayed in their defined benefit scheme.

How the charge is assessed

The charge is assessed by adding up all your pensions and ‘filling up’ the lifetime allowance like a bucket. You only get hit with a charge if the bucket starts overflowing.

Another thing to note is that drawdown pensions (except pre-A Day pots) are tested against the lifetime allowance twice.

The first test is BCE1 when the funds are first designated. The pension is then tested again on either:

  • annuity purchase (BCE 4), or
  • reaching age 75 (BCE 5A), or
  • on transfer to a QROPS (BCE 8)

To ensure there no double counting, only the increase in funds crystallised under BCE 1 are tested at the second designation.5

How the charge is applied

As I mentioned above there are two tax-rates: 55% and 25%.

These are commonly called the ‘lump-sum’ and ‘income’ rates.

It may be easier though to think about these instead as whether the money ‘leaves’ or ‘stays’ inside the pension tax regime.

For example, if you take a tax-free lump-sum on drawdown, it ‘leaves’ the tax regime – because you won’t be subject to any further income tax on it. In this case, any excess above the lifetime allowance that you take as a lump sum is charged at 55%.

If you instead take an annuity income, then you take a 25% tax charge on the excess income above the lifetime allowance plus any income tax due.6

Aha! You might now be cunningly thinking that 25% is lower than 55%, and so taking income is always better?

In reality it all depends on what income tax rate you’ll be at, as an example shows.

You take a £100 lump sum over the lifetime allowance:

£100 x (100% – 55%) = £45 after tax

Take £100 income over the lifetime allowance:

45% tax-rate: £100 x (100% – 25%) x (100% – 45%) = £41.25 after tax
40% tax-rate: £100 x (100% – 25%) x (100% – 40%) = £45 after tax
20% tax-rate: £100 x (100% – 25%) x (100% – 20%) = £60 after tax

As those being hit by the lifetime allowance are likely to be high earners (40% or even 45% tax rate), there’s probably little difference in overall tax rate between lump sum and income.

In terms of how the charge is actually paid, usually, the pension scheme will pay it if they offer the facility. This is called ‘scheme pays’. Schemes are joint and severally liable for the tax, so they like to make sure the tax is paid to avoid having HMRC on their back.

However, pensions schemes do not have to offer scheme pays in all circumstances. It is best to check in advance.

Always use protection?

As I mentioned earlier, HRMC provided protections against the reductions in the lifetime allowance. These protections each work a little differently.

What protection is right for you – or whether you should employ protection at all – will depend on your circumstances.

I’ll only cover the two protections now available to savers: fixed protection 2016 and individual protection 2016.7

Fixed protection 2016 and individual protection 2016 were introduced on 6 April 2016 when the lifetime allowance was cut to £1 million.

Those intending to apply for fixed protection 2016 had to ensure that active membership of pension schemes ceased from 6 April 2016.

There is no deadline for applying for fixed or individual protection 2016.

Fixed protection 2016

Under fixed protection 2016  your lifetime allowance is fixed at £1.25 million. You can’t already have an earlier fixed or A-day protection. Once you opt for fixed protection, you can’t make any further contributions to a pension.8

Individual protection 2016

You can opt for individual protection 2016 if your pension pot was worth more than £1m on 5 April 2016. It fixes the lifetime allowance at the lower of £1.25 million or the value of the benefits on 5 April 2016.

Unlike fixed protection, you can keep saving into a pension or accruing.

Valuing the pension depends on its type:

1. Uncrystallised benefits (i.e. not yet paying):

a. Defined contribution – at the market value of funds
b. Defined benefit – at 20 x pension plus any cash by addition
c. Cash Balance – amount available for provision

2. Crystallised benefits (i.e. already in payment):

a. Pre-A Day pensions – 25 x pension / Max GAD (Government Actuary’s Department rate) for capped drawdown at the first post-A Day BCE9
b. Flexi-drawdown – 25 x Max GAD when flexi-drawdown entered10
c. Post-A Day vestings – Value at BCE

Losing protections

Unfortunately, it’s possible to lose protections after you’ve successfully applied for them. In some cases this can be completely unintentional.

The good news is that individual protections (and primary protection) are almost impossible to lose. The only situation where an individual can lose the protection is if they divorced and their pension shared (this is where a pension is split between spouses to allow for a clean break). This reduces the level of protection on the pension. Under individual protection 2016 there is an offset mechanism, which reduces the level of lost protection.

The bad news is that the rules are much more strict for fixed protection11. An individual loses fixed protection if they:

  • increased their benefits in defined benefit scheme above a certain level;
  • contributed to a defined contribution scheme;
  • started a new arrangement under a registered pension scheme other than to accept a transfer of existing pension rights; or
  • transferred to an unregistered pension scheme (i.e. not a QROPS), from a defined contribution to defined benefit scheme (depending on circumstances) or from one defined benefit scheme to another (again depending on circumstances)

Unlike with individual protection, an individual doesn’t lose fixed protection if they are subject to a pension debit (divorce). However, they will not be able to rebuild any pension fund without revoking their fixed protection.

Flaws with the lifetime allowance

Still awake? Amazing!

It’s time we stopped explaining the lifetime allowance and started complaining about it.

First of all, what was intended to hit only the very wealthiest earners has already started to swallow up hundreds of thousands of savers. This can be seen in the data – HMRC’s take from the lifetime allowance has increased by over 1,000% in 12 years.

Likewise, annuity rates have plunged since A-day meaning that a defined contribution pot buys a significantly lower guaranteed income for life.

At the same time the lifetime allowance has drastically reduced. At the time of writing, £1m would buy only a c. £28,000 3% rising, 50% joint-life annuity12. That is less than the median household income of c.£29,000.

A third problem is that planning for the lifetime allowance is incredibly difficult. It is a moving target. It is also hard to know whether it will still be around – or in what form – in 10-30 years’ time.

Another issue is that the combination of the lifetime allowance and annual allowance could result in not only the clawback of tax relief, but also see further tax paid on pension pots. The combination of the two also results in strong incentives to be wary of saving into a pension when you’re at peak earning capacity. (i.e. when the sun is shining, ahead of a future rainy day).

But the biggest issue is the lifetime allowance is flawed in construction. Even leaving aside that the £1m allowance figure is itself completely arbitrary, the allowance is only set to increase by CPI.

Most pension schemes target returns far in excess of inflation – as do most of us Monevator readers!

The FCA advises that the projected return for equities should be 3% to 5%.13 A common benchmark for master trust pensions is CPI plus 3%. And looking back over the past 10 years, passive investors would indeed have realised returns far in excess of inflation.

This means that even a very distant lifetime allowance charge can become a real issue for those prudent enough to save into a pension for retirement.

Without labouring the point, beating inflation is the whole reason we invest. This means that the lifetime allowance punishes most those that save and invest successfully!

Looks like we’ve made it to the end

Like the annual allowance, the lifetime allowance is a complicated moving puzzle and it is worth seeking professional advice if you need it.

Assuming you haven’t fallen into a coma, please let us know of anything we’ve missed in the comments below.

  1. It’s a bit more complicated than that – what with tax-free cash and the annual allowance – but we have to at least try to simplify things! []
  2. Keep in mind that since 9 March 2017 QROPS transfers can incur a 25% tax charge if certain conditions are not met, plus a five-year look-back applies. []
  3. https://www.hl.co.uk/retirement/annuities/best-buy-rates as accessed 11/11/2019. []
  4. £56,020 = £2,801 x 20. []
  5. For a worked example, see the HMRC tax manual. []
  6. QROPS transfers count as a 25% charge. []
  7. The other protections are 2006 primary and enhanced, introduced on A-day; fixed protection at 2012 and 2014; and individual protection 2014. []
  8. Or accrue within a defined benefit pot at, roughly speaking, higher than 5% of RPI per year. []
  9. The calculation for these is quite complicated, refer to HMRC guidance. []
  10. The calculation for these is quite complicated, refer to HMRC guidance. []
  11. The rules are also more strict for enhanced protection – but I only cover fixed protection here []
  12. See: https://www.hl.co.uk/retirement/annuities/best-buy-rates as accessed 11/11/2019 []
  13. These are the FCA prescribed projections. []

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{ 79 comments… add one }
  • 1 Lurking November 28, 2019, 11:00 am

    This article lays things out pretty well. A couple of notes and amplifications.

    First, ‘scheme pays’ is actually the term use for when pension contributions exceed the annual allowance, rather than the lifetime allowance. While it’s true that the pension provider and the member are jointly liable for lifetime allowance penalties, ‘scheme pays’ for exceeding the annual allowance is mandatory only where the £40,000 annual limit is exceeded, and only voluntary where a tapered allowance (say) has been exceeded.

    This means that a 45% taxpayer who exceeds a tapered annual allowance and whose pension scheme does not offer ‘scheme pays’ loses 45% of their contribution to tax. If they are also above the lifetime allowance and in higher rate tax in retirement, they will pay 55% on withdrawals. These add up to 100% tax. This is just one of many cases where saving into a pension produces a worse tax outcome than not saving into a pension.

    Second, the reductions in the lifetime allowance have been worse than its simple existence. Aside from the goalpost-shifting disincentives, people close to retirement when it is reduced are motivated to take fixed protection and then retire earlier than planned, rather than carry on working. And the protection regimes take no account of inflation, so that in a decade or so (if it survives) the inflation uplift in the current lifetime allowance will overtake fixed protection 2016, rendering it useless.

    Third, fixed protection is appallingly easy to lose by mistake, and a massive trap for the unwary (or even wary but unaware) that leads to an otherwise avoidable tax loss that could be on the order of £62,000 or more. Pension auto-enrolment is a case in point. Join a new employer and forget to opt out of pensions within a month, for example. Or accidentally mark a SIPP fees payment as a ‘contribution’. A loss of tens of thousands of pounds for a simple paperwork or timing ‘foot fault’ is entirely possible.

    And finally, note that BCE5a, applied on reaching age 75, can lead to a lifetime allowance penalty on all nominal gain in the pension since crystallising through BCE1, with no offset for inflation. This motivates drawing down all the gains, both nominal and real, before reaching age 75. Arguably one might want to keep a decent buffer here against the potential costs of long-term care, but the silly tax rules motivates drawing down sooner rather than later.

    It’s a horrible system all round.

  • 2 DevonshireDozer November 28, 2019, 12:11 pm

    This is outstanding. I’ve spend ages wading through ‘official’ web & paper pages, reading half arsed articles in the MSM etc. to try & understand it & yet your piece here sets it all out & sums it up in a very digestible way.

    Your remarks at the end, re the way in which Sir Humphrey & his well provisioned friends are going to stitch us all up, are right on the money. Which of the windbags now standing for election has a policy for this? Or any understanding of it & the underlying issues, particularly for the self employed?

  • 3 moorgate man November 28, 2019, 1:50 pm

    Excellent Article. I recently inquired with Hargreaves regarding testing at age 75. They did confirm that if say one takes a 2016 Fix at 1.25M [ which isn’t indexed ], should the standard limit ( currently just over 1M ) be higher than 1.25M at age 75, then that is the figure that is used. If you run compound interest at the current standard limit of approx 1M for 15 years at say 2 or 3 %, it can easily go over the original fix. Clearly encouraging one still to burn down capital above inflation but at least doesn’t ‘fix’ at what would be a lower figure.

  • 4 Matthew November 28, 2019, 2:29 pm

    Keep bonds in pension and equities in isa as much as possible to minimise tax upon the part that generally grows faster and to reduce the risk of breaching the LTA, and rebalance as needed

    I wonder if foreign pensions are a way to skirt the LTA?

  • 5 John B November 28, 2019, 2:35 pm

    Excellent article. I assume there is no downside into going into DC drawdown at pension access age (55, possibly rising if they remember to legislate) if you are under the limit*. If you are over, I guess you could wait for a crash, but its always likely it will rise over inflation, dividends included.

    * with an extra frozen DB pension accessible at 60, I guess you can at least predict that its index linking will track the scheme’s value, so if that is also under at 55, its likely to be true at 60.

  • 6 MikeW November 28, 2019, 2:38 pm

    Thanks: well written – it is a topic rarely attacked well.
    One perhaps unexpected impact for some is that the LTA is quite a disincentive to work…perhaps at a time where they have much knowledge to share.
    I think for those who are close to it, particularly if they have one or two DB schemes that will kick in later, then crystallising early to avoid that LTA makes a lot of sense.

    I do appreciate this is very much in the category of “first world problems” for those impacted.
    The test at 75 (BCE 5a) is a nasty thing that might well trip more people up.

    Perhaps this is a GoodThing™ – making those wealthy few who are looking at it select another course for that next stage of their life…..

  • 7 Doc November 28, 2019, 2:56 pm

    Once one has crystallised funds that exceeded the LTA, then you are no longer able to take any further tax free Pension Commencement Lump Sums.

  • 8 John B November 28, 2019, 2:57 pm

    Always a interesting dilemma, does society want people to give up when they’ve won the game financially, by retiring early, or giving up after a 50s redundancy, or get them back doing something. Those people might boost the economy more doing their specialty, or might open the way for younger, keener people who need the job more. They might use their skills elsewhere, at high-powered charity work, or for me, having a bonfire in the nature reserve this morning!

  • 9 Mr Optimistic November 28, 2019, 3:18 pm

    Amazing effort, take the afternoon off!
    @Doc, do you mean the commencement lump sum can only be drawn on funds with value up to the LTA, typically 25% of value so max is a quarter of £1.055 M ( I wish)?

  • 10 Doc November 28, 2019, 3:40 pm

    @MrO. Yes. If you were lucky to have a DC pot of £1.5M and had no protections, then your maximum tax-free lump sum would be .25*£1.055M=£263,750 and not .25*£1.5M=£375,000. Definitely a firstworld problem.

    But with the high CETVs these days, it is maybe not as rare as people think. Indeed, for someone with a short life expectancy and a large DB pension, the CETV would be very nice indeed.

  • 11 The Investor November 28, 2019, 4:09 pm

    @all — Cheers for the informed comments so far, they’re already adding to The Detail Man’s article / labour of love / cruel and unusual punishment.

    Quick request: I know it’s a pain but if you use an acronym for the first time in the thread, it’d be great if you could please use the full phrase first then the acronym in brackets, just to get it defined.

    Pensions are confusing for neophytes enough as it is! 🙂

    On that note: CETV = cash-equivalent transfer value.

  • 12 Mr Optimistic November 28, 2019, 4:10 pm

    @Doc, thank you. That’s what I hoped. Incidentally, I took a CETV from one dB scheme, factor of 31 but the pension foregone wasn’t too high.
    Now to read the article again. A very patient person wrote it 🙂

  • 13 nf1 November 28, 2019, 5:02 pm

    How about a follow up article discussing the options for someone faced with breaching the LTA. When close to the LTA and retirement age, the investment can become asymetric: investments go up and the taxman taxes 25%/55% – so need to overshoot to compensate (with commensurate increase in risk); investments go down and you bear the whole loss. It’s a conundrum!

  • 14 Rob November 28, 2019, 5:08 pm

    From the article…For example, if you earn £80,000 a year then you are a 40% tax rate payer. If you put £600 into your pension out of taxed income, the government will put in £400 (40% of the total contribution) to bring you up to £1,000.

    This isn’t factually correct. If you put £600 into your pension out of taxed income the government will put in £200 to bring you up to £800 and they’ll give you £200 cash. It’s a small point but worth considering because higher rate taxpayers do at least get some tax relief money in the back pocket along the way.

    The thing I’ve never understood is why there’s a lifetime allowance in the first place. The government limit tax relief by capping contributions so why have a limit on the pot too?

    Definitely a First World problem. It’s not as if anyone based on today’s contribution limits is going to build a £1m pension pot by accident. Still; if you’re going to have problems the First World variety are the best to have.

  • 15 The Details Man November 28, 2019, 5:21 pm

    @all – thanks for the kind words and all your comments. Makes the labour of love worth it.

    @Rob – that’s right. I’ll pass on an edit to TI to put in to the article. Thanks!

  • 16 Tom November 28, 2019, 5:49 pm

    One thing I still can’t work out is the order of priority with the tax:

    Say I have £1.5 million in my SIPPs when I reach 55 (which for argument’s sake, let’s say is today, so it is over the LTA).

    To keep it simple, I take no tax free lump sum. I start drawing from my SIPP at the rate of £25k a year.

    a) Does that first £25K get taxed with the additional 25% over the lifetime allowance penalty rate? OR

    b) Can I keep drawing down £25k a year until I have hit the LTA – only at which point the ‘over the LTA’ penalty rate kicks in – which at £25K a year would take me 42 years…

    If it’s the latter and we’re saying you can SPEND up to £1.055m before you encounter a tax penalty (and surely part of this whole FI business is not being profligate spenders)- I’m not sure I care because I’d only start paying over LTA penalty rates of tax when I’m 97.

  • 17 Stoic Cyclist November 28, 2019, 6:40 pm

    Thanks for the excellent article, much appreciated.

    I disagree that the 1M£ limit is too low. I think it is about right. The point of pensions is to incentivise people to provide for themselves in retirement and not be a burden on the state. In my view, beyond allowing for a comfortable standard of living the state should not be giving any more tax breaks. And I think retirees should be able to live pretty comfortably on income from 1M£. 

    You can get a safe income of about 30k£/yr from 1M£ capital (3% SWR, or annuity rates are close to this as the article says), and retirees will get the state pension as well, so gross income about 38k£. After tax, which is lower for retirees, that is net income of 33k£.
    For my family (with retirement far in the future) I feel that we have a very comfortable life spending 15k£/person/yr on non-housing expenses and holidays. 33k£/person for a two-income couple sounds luxurious, and for a single-income couple still fine. This is assuming the mortgage is paid off by retirement, but surely most well-off retirees would have done this.

    On a related point, I think people get excessively worked up about the 55% tax rate above the lifetime limit. If they are higher rate tax payers, and are salary sacrificing and getting employer NI kicked in too, then the tax benefits going in nearly cancel the 55% tax on the way out. To illustrate, for a marginal pound that could either go in pension and be hit by 55% tax on withdrawl, or be taxed now, saved in an ISA, and spent in retirement:
    * put into pension: £1 * 1.13 (employer NI) * 0.45 (55% tax on withdrawal) = £0.51
    * put in ISA: £1 * 0.58 (40% tax + 2% NI) = £0.58

    So, effectively the tax penalty of exceeding the limit is only 12%, not 55% (though I’m sure it doesn’t feel that way when you pay the 55%). I’m planning my pension contributions to get close to the limit, but I’m not losing any sleep over the possibility of going over.

  • 18 Moneydog November 28, 2019, 7:44 pm

    Re: foreign pensions. They are not subject to LTA, providing the scheme is not UK-registered and no UK tax relief was applied to contributions. Therefore, unlikely to make sense for most UK residents (since contributions will be after tax), but might make sense for those temporarily resident abroad. Just make sure that the foreign country has a dual taxation treaty in place with the UK that covers pensions.

  • 19 ZXSpectrum48k November 28, 2019, 8:21 pm

    @TDM Great article. LTAs are so unfair. Given real yields on inflation-linked Gilts are at -2%, a genuine inflation linked annuity above 2.0-2.5% is very hard to construct. So realistically DC pension holders are being limited to an inflation-linked sum of <£25k/annum. Meanwhile, given the 20x factor applied to DB pension holders, they can receive £50k/annum, inflation-linked. How is that fair?

    I can easily understand why the government might want to limit how much you put into a pension, the annual allowance. Why, however, limit how much can be taken out? Asset values are likely to be high when bond yields are low, and bond yields are the driver for annuity rates. You are most likely to hit the LTA when annuity rates are low (like now), meaning that the purchasing power of your pension, in risk-free terms, is at is lowest. If you have to have LTAs, surely they should be linked to inflation-linked Gilt yields, to preserve the risk-free purchasing power, not arbitrary numbers like 20x for DB or £1.055mm for DC pensions.

    It's also worth remembering, that while it might be hard to breech the LTA cap these days with an annual allowance of £40k, the annual allowance was over £200k for most of the late 2000s (peaking at £255k in 2010/11). That those annual allowances were, frankly, barmy, is hard to argue against but those people put their money into their pension in good faith.

  • 20 marked November 28, 2019, 8:58 pm

    Fabulous article. I haven’t fully digested it yet, but have a difference of opinion on tax relief (the example using a 40% tax relief and you putting in £600).

    The article says you put £600 in (at 40% tax relief) and the govt will “put in” £400. This isn’t quite true.

    In the example if you put £600 in the SIPP (or whatever pension vehicle) the pension provider will claim the basic rate (the first 20%) but the following 20% tax you claim back through your tax code. This is important to note, since you actually have that recovered outside the SIPP wrapper – e.g yours to either add into the SIPP (and amusingly get another round of tax relief on top) or spend/save as you please. I find this amazing.

    And whilst the Details Man does explicitly say salary sacrifice is good as you get the National Insurance added too, I cannot stress how important this is for a basic rate tax payer as it’s a combined 32% Relief. The trouble is I find the bigger corporate employers will only do that to their own AVC and Money Purchase vehicles opposed to one you may prefer. Of course this is quite often offset by them adding a percentage in too, but once you get past that limit the choice rarely widens.

  • 21 Whettam November 28, 2019, 9:03 pm

    Wow thank you @Details Man really comprehensive, couple of observations:

    – I don’t necessarily agree that those being “hit by the lifetime allowance are likely to be high earners” a 4% withdrawal rate on a million pound pot, is comfortably only in the basic rate band + most will take tax free income and stick this in ISA so their taxable income even at higher withdrawal rates should still only be basic rate taxpayer

    – one clarification on BCE 5a does this look at the money you have already put into drawdown again or just the non crystallised portion

  • 22 marked November 28, 2019, 9:20 pm

    Having fully digested now I like the comment on the Lifetime Allowance incrementing at CPI per year being a problem for pension providers since they try to achieve CPI plus 3%.

    However two points should be made here.

    Firstly the CPI increase is made on the maximum LTA, so someone starting now (with the 40K annual allowance that does NOT seem to increase with CPI) will find it tougher to get to the max. Indeed a CPI of 3.8% would increase the LTA by 40K so someone starting their pension journey will find it tough to ever get to the maximum.

    Secondly, and conversely to above, it is not safe to assume the LTA will rise with CPI on a yearly basis. It’s at the discretion of the Chancellor as wasn’t enshrined into law. In other words can be tinkered with and successive Governments and Chancellors rarely tinker upwards!

  • 23 Doc November 28, 2019, 9:31 pm

    @Tom (comment #16), the calculation of pension “pot” value against the LTA occurs when one of these BCEs occur. It should be noted that you can crystallise part of your pension without actually drawing that money.

    One could “crystallise” the pot and leave it invested. The pension providers essentially create another account for you, so you have a uncrystallised fund and a crystallised fund. You withdraw from the crystallised fund as and when you wish.

    So in your example, you could crystallise £1.5M now and pay the tax charge now. Or you could crystallise £1.055M (and pay no tax charge) and leave the rest uncrystallised, hoping that a kind/sensible government comes along to remove the LTA all together.

  • 24 Willy November 28, 2019, 9:33 pm

    An excellent article, thanks. Does anyone know if there are any issues or pitfalls with the following scenario when someone is no longer working:
    i) Having a SIPP with Hargreaves Lansdown where you go into drawdown at 55 and take 25% tax free cash. The drawdown pot is left to increase (hopefully)
    ii) Having a DC pension pot with a former employer, leaving it a few years after event i), then transferring to a SIPP with Hargreaves Lansdown, going into drawdown and taking 25% tax free cash.
    Can you effectively treat each SIPP completely separately with two separate drawdowns and two separate 25% TFC withdrawals? Would you end up with one drawdown pot with HL or would there be two separate ones?

  • 25 The Details Man November 28, 2019, 11:12 pm

    @Whettam – BCE5a effectively works the same as if somebody bought a lifetime annuity or makes available money through drawdown or flexi-access. Only net growth in the drawdown fund or the left over from flex-access is tested. Here’s a link to the HMRC tax manual which explains how it works and gives an example: https://www.gov.uk/hmrc-internal-manuals/pensions-tax-manual/ptm088650#IDADZNKB

    @marked – TI has now updated the text, thanks for spotting too. Regarding salary sacrifice, it’s a mixed bag on what an employee will get (sadly the choice is out of their hands). A lot of places do net pay (i.e. contributions out of gross salary) – for example NOW:Pensions. Some do not, like NEST. The argument against net pay is that it hurts low paid workers as they don’t get the tax relief on earnings below the personal allowance. Regarding CPI increases to the LTA, it’s baked in via the Finance Act 2016 (amending FA2004). Of course, completely open to future chancellors to tinker (which one has to think it likely).

  • 26 Ben November 28, 2019, 11:58 pm

    When you get near 1M, put the pension in gov bonds and never breach the LTA. Then put 1M in equities outside. What’s the downside?

  • 27 James November 29, 2019, 8:35 am

    “If you put £600 into your pension out of taxed income, the government will also put £200 into your pension and you can claim £200 relief from HMRC. This gives you a total of £400 tax relief.” These figures are not quite correct; if you contribute £600, you get £150 tax relief paid into the pension and £150 relief outside the pension, giving a total of £750 in the pension for £450 foregone taxed income (450 = 750×0.6).

  • 28 Gentleman's Family Finances November 29, 2019, 12:08 pm

    thanks for posting this – I can tell that it must have taken you some time to pull it together.
    Pensions are a complex tool.
    I’m another 30 years from access of the pension but I honestly think that with strong tail winds my £200k SIPP and DB pension could grow above the LA by then.
    Of course things will change and laws are made to be amended.

    From an FI perspective, Pensions are a double edged sword. You can save a lot of money (salary sacrifice anyone?) and can be used later in life (and potentially pay less tax on the way out) – but are useless if you need to bridge the time from now until 55+.
    The LTA complicates things but there’s always wriggle room within the rules – posts like this can help frame our family office decisions for the future.
    Thanks!

  • 29 Gentleman's Family Finances November 29, 2019, 12:26 pm

    @marked #20.
    I had salary sacrifice at my last place and money was paid into the AEGON pension but I was able to transfer it out to my SIPP.
    It’s a matter of filling in a few forms every few months – you can maybe even benefit from a transfer offer (£50 if you transfer £10k).
    As far as I know, no DC workplace pension locks you in so you can transfer if you like.

  • 30 The Details Man November 29, 2019, 12:37 pm

    @James – have a look at this helpful calculator: https://www.hl.co.uk/pensions/tax-relief/calculator

  • 31 Mr Optimistic November 29, 2019, 7:11 pm

    It’s off topic a bit but I have about 500k in a sipp and want to take out some or all of the tax free lump sum this fiscal year. Since I don’t want to have to sell anything to get the cash ( it’s 50% cash at the moment), but I want to leave some cash in the crystallised element, I anticipate plenty of head scratching on my part as to what elements to crystallise. Easiest to just treat the lot in one go but that means I’ll have a lot of uninvested cash hitting my accounts.

    May be a future article on drawdown strategies for the hard of understanding….quickly 🙂 ?

  • 32 Gizzard November 29, 2019, 7:45 pm

    Yes, I believe you can do both if those things. I have done i. My wife has a SIPP with HL. Each year, she contributes £2880. When tax relief is eventually added, she draws it down, taking 25 percent. The balance is then added to her pre-existing drawdown SIPP. So to cut a long story short, you’d end up with a single drawdown SIPP.

  • 33 Vanguardfan November 29, 2019, 8:00 pm

    Could you say something about what happens on death? (Re the LTA).
    Another conundrum that makes my brain ache is whether it’s better to pay the LTA charge from a DB pension or a DC pot. Is there any clear cut preference as to which to crystallise first? (Assuming neither exceeds LTA by itself)

  • 34 Pingpong November 29, 2019, 8:18 pm

    Hello everyone this is a first time post for me but this whole area of Lifetime Allowance (LTA) is interesting now I am getting close to retirement.
    My question for the experts on this excellent website is as follows:
    Assuming I have a 20K defined benefit pension (worth 37.9% of the LTA as of today) which I fully intend to take as a income stream lets say with immediate effect.
    I also have £450K in 3 defined contribution pensions which I do not intend to ever drawdown but leave as inheritance for the next generation of Pingpongs. So in ten years time when I am assessed under BCE5 and the defined contribution pensions have grown at lets say 5% a year (compounded & after all charges) to a figure of £733K. Then will this £733K figure be calculated as a percent of LTA where the LTA is inflation indexed for the full ten years or against the original LTA today when I took the defined benefit pensions ?

    Any advice much appreciated as I would be close to breaching the LTA.

  • 35 Vanguardfan November 29, 2019, 8:56 pm

    @pingpong, after you take your DB you will have 62.1% of the LTA left. When you next have a BCE, the test is against the LTA at that date.
    If you die without crystallising then I believe you lose the 25% tax free, so I think it is probably best to plan to take your tax free cash at 75 – maybe give it to the ping pongs then?? (But this is where my brain starts to fry so maybe TDM will come and clarify- this is similar to my situation too)

  • 36 BBlimp November 29, 2019, 9:28 pm

    I agree. 56k might also be achieved by mid earners with very long service in defined benefit schemes as well ( and let’s remember of that mid earning, contribution rates can be in mid teens in these schemes as well)

    This harks back a bit to the ‘what is rich’ discussion from last weekend… 80k salary, £1m ISA limit, the LTA… at what point are people fair game to get whalloped?

  • 37 Matthew November 29, 2019, 9:56 pm

    You could technically divorce and get a pension sharing order so it counts towards your “ex”‘s LTA, you have more unmarried couples nowadays

  • 38 Andrew November 29, 2019, 11:14 pm

    The difficulty I have, is trying to predict the returns of my pension.
    I’m 35, but have already accrued a pension of approx £553,000k.
    I’m inclined to simply stop now, because I’m having to guess if my returns over the next 20 years might exceed the inflation adjusted lifetime allowance or not. However, on the flip side, I’m caught out by the 62%+ rates which come with loss of nil-rate personal allowance once you exceed the 100k income band etc (the reason I have historically paid in so aggressively to try and keep this personal allowance). I do ISAs also, but find the worst thing about the lifetime allowance is this doubt and 2nd guessing I’m already having… (and I’m still 20 odd years away from 55… and even further from state pension age). How can I possibly know what to do or predict the minefield of rule changes, unknown investment returns, unknown inflation rates etc.
    Thanks for the article – I don’t imagine there is an answer to my dilemma, unless someone has a crystal ball. I’ll just try to diversify with ISAs, and possibly other tax efficient options like EIS/VCT’s (which I’m starting to look into).

  • 39 Stephens November 30, 2019, 12:07 am

    TDM thanks for a great article on this difficult topic
    I only stumbled across the LTA this year. Having originally planned to continue to contribute to my pension until retirement age (like a good citizen) I suddenly realised that following research (including the creation of a DIY spreadsheet) I urgently had to not only stop contributions but actually go into drawdown Asap to avoid the punitive LTA related tax rate at 75. Whilst we can argue whether or not £1m is the right number my beef is that the LTA is very poorly covered by HMRC and a cynic could argue this was by design in order to create a tax windfall for HMRC from the unwary. When I talk to my friends hardly any of them are aware of the risks.

  • 40 BBlimp November 30, 2019, 9:14 am

    Andrew I’m no tax expert but contributing heavily to a pension to avoid the loss of the personal allowance seems like sensible tax planning, whereas limiting pension contributions in your 30’s because you may breach the LTA seems more like guess work. None of us can possibly know where the LTA will be in 20 years time. It was 1.8m a few years ago and although the direction has so far been downwards who knows what the years will bring. As early as the next parliament it looks likely the rules around pensions will change because of doctors finding themselves in the position of paying to go into work.

    For a bright guy with a good head for figures and appreciation of taxes this might a sound painful way to part with your cash… but it might be time to visit a Financial Planner ?

  • 41 PC November 30, 2019, 11:39 am

    Thanks for this article. The LTA is something that is always nagging away at me.

    I’m fortunate to have a SIPP that’s getting close to the LTA. My plan so far has been to stop contributing and to crystalise if I actually hit the LTA but not to actually start drawing funds right away.

    What I haven’t allowed for is a BCE 5A at 75.

    I don’t quite understand what it measures – say I crystalise at age 60 and the value is equal to the LTA 1,055,000. 15 years later and maybe I’ve started taking some drawdown and the markets have been kind and the market value of my SIPP has grown to 1,250,000.

    Would I be liable for 55% tax on 1,250,000 – 1,055,000? (ignoring inflation and any changes in the LTA)

    Could I avoid this by simply adjusting the amount I drawdown so that I keep the total market value of my SIPP equal to the LTA?

    If this means taking more than a SWR (safe withdrawal rate), could I save some of what I’ve taken out of my SIPP and put it into an ISA?

    Thanks

  • 42 Naeclue November 30, 2019, 2:07 pm

    Wow, what a fantastic article! I wish something like this had been available several years ago when I had to figure it all out for myself. I feel extremely fortunate to have been able to fill my SIPP prior to 2012 and take FP2012. Labour’s previously very high annual contribution limits helped me as well.

    I only draw income from my SIPP so that I stay within the basic rate limit and that means it is highly likely that I will exceed the LTA at the age 75 test and pay the 25% charge. I am fairly sanguine about that though. Under current rules I can pass on my SIPP to beneficiaries and they can continue to draw and pay tax no higher than basic rate should they choose to (that would be my advice to them).

  • 43 Naeclue November 30, 2019, 2:15 pm

    @PC, one way to think about the LTA tests is in terms of summing percentages. Whenever you have a BCE, a test is made against the LTA at the time (which could be a previously protected LTA). These percentages add up and provided the sum stays below 100%, there is no LTA charge.

    In your example, crystallising at the LTA means you use 100% of the LTA. In that case any nominal growth at all at the age 75 LTA test would put you over the LTA (whatever it might be at the time).

  • 44 Naeclue November 30, 2019, 2:20 pm

    @PC:

    “Would I be liable for 55% tax on 1,250,000 – 1,055,000? (ignoring inflation and any changes in the LTA)” Yes, or don’t forget you could choose to pay only 25% provided you leave the excess in the SIPP.

    “Could I avoid this by simply adjusting the amount I drawdown so that I keep the total market value of my SIPP equal to the LTA?” Yes, but all that matters is the test at 75, you can exceed it before you reach 75 without penalty.

    “If this means taking more than a SWR (safe withdrawal rate), could I save some of what I’ve taken out of my SIPP and put it into an ISA?” Of course. You can do what you like with it, but are restricted to paying no more than 4k per year into another pension.

  • 45 PC November 30, 2019, 3:34 pm

    Thanks @Naeclue That’s clear now.

    How do normal, non Monevator readers cope with this .. or me at some point in the future.

    “All” you need to do is project the value of your SIPP at one uncertain point in time, when you start to draw on it, its value at a 2nd point when you reach 75, a safe withdrawal rate, an asset growth rate and an inflation rate.

  • 46 Naeclue November 30, 2019, 6:10 pm

    @ping-pong. If it was me, I would crystallise your DC pensions now, taking the 25% lump sum. Give that lump sum away, or maybe put into a discretionary trust and leave the rest to grow. That way you would reduce the risk of exceeding the LTA when you are 75. The main tax risk here is the tax free lump sum is brought into your estate and maybe subject to inheritance tax if you don’t survive 7 years after giving it away.

  • 47 Naeclue November 30, 2019, 6:23 pm

    A lot of people seem to be terrified of exceeding the LTA. I think they forget that they received tax relief on the way in. Provided you got 40% or more tax relief on the way in, and drawdown whilst staying within basic rate tax, you are no worse off if you exceed the LTA than you would have been if you had paid into an ISA instead. Better off in some respects as the residual money in the pension will not be subject to inheritance tax, unlike money in a ISA.

  • 48 Pingpong November 30, 2019, 6:28 pm

    @Naeclue. That is worth serious consideration (ie taking 25% lump sum from DC pensions now). The other key dilemma is arriving at the most realistic scenario for the growth of my DC pension of 450K over ten years. If I plug in a 5% growth with a 15% standard deviation into a pension calculator called Flexible Retirement Planner best case I get a DC valuation of 1186K which is well over the LTA when assessed at BCE5 or worst case 380K which is well under. The most realistic case scenario is borderline to trigger the LTA !!
    Best laid plans of mice and men should I crystallise 25% lump sum now or wait a few years to get better certainty on the outcome of my DC valuation !! TBH I am at the point of paralysis by analysis !!

  • 49 Vanguardfan November 30, 2019, 7:14 pm

    @pingpong. If you crystallise the DC pot now, you may then incur an LTA charge on the DB pension when you take it. I have decided I would rather pay any LTA charge from my DC pot than my DB pension (I don’t know if that’s mathematically justified, it just feels better to me, as I’d like the maximum secured income I can get from the DB; the DC, like yours, probably won’t be touched once the tax free cash is taken). So my thinking is to crystallise the DC pot just after I take my DB pension when I turn 60. I’m not actually too bothered about LTA charge on the DC, as it’s all extra money.
    If anyone can give me an argument for crystallising the DC before the DB I’d be interested to hear it.

  • 50 Pingpong November 30, 2019, 7:22 pm

    @Vanguardfan. I fully agree with your analysis the sequential action should be to crystallise DB first then DC. The timing on when the DC is crystallised I think becomes more difficult to determine with any degree of accuracy. Should I wait 1 year 2 years etc to improve the accuracy of the DC valuation as there would be a shorter time horizon to reaching BCE5.

  • 51 Naeclue November 30, 2019, 8:01 pm

    @ping pong and vanguardfan, I am not very familiar with the DB pension rules as I don’t have one. If you take a DB pension of 25k, valued at 500k I think, and that puts you 100k over the LTA, what happens and do you have any choices over the matter?

  • 52 ChuangTseu November 30, 2019, 8:03 pm

    @Stoic Cyclist : absolutely right. Even better is also comparing to £1 outside any wrapper, since high earners struggling with the lifetime allowing will probably max out their ISA anyway (kinda no brainer) and would rather compare a salary sacrifice into the pension vs getting the dough asap and investing outside any wrapper.

    You’d then have to compare between:
    * salary sacrifice into pension: £1 * 1.138 (employer NI) * 0.45 (55% tax on withdrawal) = £0.5121
    * normal investing (40% tax rate + 2% NI): £1 * 0.58 = £0.58
    * normal investing (45% tax rate + 2% NI): £1 * 0.53 = £0.53
    * normal investing (infamous “60%”” tax rate + 2% NI): £1 * 0.38 = £0.38

    Now, on top of that, considerer that normal investing is not sheltered and thus incurs divident taxes + capital gain taxes. So if you expect some reasonable return out of you investing, then all those taxes might hurt to a significant extent your total vs the sheltered pension.

    From a personal simulation spreadsheet (that I may eventually share), the TL;DR would be something like, in order of importance:
    – always match your employer contribution (no brainer)
    – try your best to escape the eggregious “60%” tax rate (if your salary is way above that, tough luck, + you won’t have much room for optimisation anyway due to the tapered pension allowance)
    – for every pound above that, it becomes complicated, because it’s hard to precisely measure the impact of dividend and capital gain tax (you may optimise with some form of bed&breakfasting, you may avoid divident paying stock, etc.) but unless the total tax is punitive then in my simulation if only makes a difference of a few tens of £k for a final pot over £2M after 30 years so probably not worth the hassle of waiting until 55, but no reason to loose any sleep either.

    On a last note, a non-UK citizen that intends to only work for a few years in the UK may want to maximise its pension contributions before going back somewhere else in the world. And let it grow from there without to much risk of ever hitting the LTA. (Unless you’re a US citizen, then just don’t, and get a good financial advisor).

  • 53 The Details Man November 30, 2019, 8:27 pm

    @vanguardfan / pingpong – there is a planning opportunity around when you time your crystallisations. As you say, generally speaking, it would be wise to crystallise the guaranteed income first (i.e. DB and lifetime annuities) then DC/AVC/pots for flexi-access drawdown. Also, bear in mind the disconnect between how DB and DC are valued (like the annual allowance). DB is generally valued on 20 x year 1 income, favourable compared to DC. However, take into account what each of your schemes allows for: lump sum, the age you can take the pension, whether you are forced to take the pension.

    Worth reiterating a point made by several comments and in the annual allowance piece. Paying a tax charge is only bad if the net benefit is not worth it! Often, the benefit of ‘free money’ from an employer and the tax-efficient wrapper means that contributing to a pension, even where an LTA charge is likely, is worth it.

  • 54 Vanguardfan November 30, 2019, 11:50 pm

    @naeclue. I don’t completely know as I haven’t done it, maybe TDM knows, but what I believe happens is something like this. If you crystallise the DB and it takes you over the LTA (either by itself, or because you’ve previously used some of the LTA up), then you pay the LTA charge as an additional surcharge on your pension (ie you pay 25% on the income produced by the excess above the LTA). I guess that means in your example you pay 25% of the £5k income produced by the £100k excess above the LTA, forever.

  • 55 Vanguardfan November 30, 2019, 11:59 pm

    @pingpong (50). I’m not sure why the timing of the crystallisation matters particularly?
    Once you get passed taking the DB, why not crystallise straight away? I guess you might miss out on a bit of tax free cash but I’m not sure how precisely you can estimate or time it. Or if you want to maximise it just wait until you are 75 to crystallise and pay the tax – after all, it’s only a tax on the growth of your pension, it’s not a 100% ceiling.

  • 56 Vanguardfan December 1, 2019, 12:29 am

    @naeclue https://www.bma.org.uk/advice/employment/pensions/lifetime-allowance
    At the end of that link is an example of how the tax charge is paid in a typical public sector DB pension. It’s reminded me why I had concluded I should take the DB first and pay any LTA excess charge from the DC. Essentially if I take it from the DB then I pay 1/20 of the 25% tax charge every year, so if my pension is in payment for longer than 20 years I would end up paying more than if I paid the 25% charge from a DC pot put into drawdown (I think, I don’t really know how it’s done for the DC). Maybe TDM can help again…

  • 57 PMonkey December 1, 2019, 9:07 am

    Thanks for the clear article.

    The lifetime annuity has an annuity factor of 34 (ie. 1,000,000 / 29,000 =34) whereas the Scheme Pension is converted at a factor of 20.

    Most Scheme Pensions have spouse benefits and increases in payment so this disparity is often the case. This is the real flaw in the framework. Public sector pension or those lucky enough to be in a DB pension can get £50k for £1m whereas private sector DC equivalent is just £29k. Public sector can take 72% more pension without a tax charge!!

    This is why I don’t feel at all for the doctors campaigning against the annual allowance and have a concern that they have too much influence.

    I’d love an article on Scheme pension / Public sector versus Private sector DC that really spells out the advantages the former have.

    Long time reader, first time commenter.

  • 58 The Details Man December 1, 2019, 11:52 am

    @vanguardfan – that’s broadly right. For a pot put into drawdown the pension provider deducts the cash amount out of the drawdown fund. There’s a good, but long, paper from Royal London which sets out some examples it’s called “why paying a tax charge isn’t always a bad thing”.

    @PMonkey – thanks for breaking the duck. I agree with your sentiment r.e. Public sector vs DC. Though I do have some sympathies for the doctors. There are some peculiarities that mean they are particularly affected by the taper.
    Leaving that aside, I’m thankful that they’ve managed to get the silly taper rules in front of politicians in a way us accountants haven’t been able to. Despite our years of pointing out how stupid the taper is, we got nowhere. Not that I think there will be a change anytime soon.

  • 59 Pingpong December 1, 2019, 2:21 pm

    @Vanguardfan and TDM I know fully understand why crystallising your DB first is more cost effective based on your comments
    Essentially if I take it from the DB then I pay 1/20 of the 25% tax charge every year, so if my pension is in payment for longer than 20 years I would end up paying more than if I paid the 25% charge from a DC pot put into drawdown.
    The logic behind the timing of crystallising my DC after the DB is I will have a fixed %LTA remaining once I take the DB. As an optimisation strategy I could calculate every year (after DB crystallisation) when is the best time to take the 25% tax free lump sum from the DC based on forecasting growth of remaining DC fund to BCE5 in an attempt to maximise return but without breaching unused %LTA. Hope that makes sense. In effect I am trying to get as close to 100% LTA without breaching it at the time of BCE5 assessment

  • 60 Jon December 1, 2019, 5:46 pm

    Sorry if this has been said in other comments but…. you don’t need to crystallise the whole thing at once. I am fortunate enough to have got a stupidly high transfer value from my DB pension for 16 years of my life with a high-street bank. I took the money (just below the LTA) and transferred it to a SIPP. With other DC schemes and SIPPs I was well over the LTA. I crystallised a portion that came to an amount just below the LTA (and took my 25%). At 55, am living off income from the crystallised element (even though it is not explicitly split as such by the SIPP provider). The rest isn’t “tested” again until I am 75. I have 20 years to hope the rules change or I will have to face a tax bill at that point. It puts me in the strange position of considering extracting more than is tax efficient from an income tax perspective just to keep a lid on it. First world problems I guess, but the LTA is bonkers.

  • 61 Naeclue December 1, 2019, 11:00 pm

    @Vanguardfan, thanks for the bma link. I can see how DB pensions are reduced when the LTA is exceeded. For someone with both DB and DC pensions, it is not at all clear to me that the DB pension should be crystallised first. Take for example someone with a 600k DC pension pot and 30k DB pension (valued at 600k). With a 1M LTA, that is 200k over the LTA, implying a 50k reduction. If the DB pension is taken first, the DC pension is penilised by 50k and you end up with a 100k PCLS + 450k in a drawdown fund. If the DC pension is taken first, you end up with 150k PCLS + 450k in a drawdown fund, but the DB pension is reduced by £2500 (50k/20).

    Now if you assume a safe withdrawal rate from the DC pension of 4%, taking DB first would give total gross income of 52k (30k DB + 550k*4% DB). Taking the DC pension first would give total gross income of 51.5k (600k*4% + 30k DB – 2.5k reduction). So at first sight the DB first rule looks better (by £500), especially as the 4% safe withdrawal rate is not actually safe). But, with DC first, you get an extra 50k tax free cash and if you are careful with use of allowances the income from that can be tax free. That is a basic rate tax saving of £400 (50k*4%*20%), narrowing the gap to only £100 gross. As well as that, although the 4% safe withdrawal rate is not safe, over most historical periods it leaves a substantial legacy, so taking DC first is likely to leave a higher legacy than DB first (at the small risk of no legacy and the DC money running out).

    To me it seems to be a personal decision on whether DB or DC first and comes down to trading guaranteed DB income against tax free cash (in this case £2500 DB income vs. £50k tax free cash). Given the choice I would probably go for the extra income, but not everyone might want that.

  • 62 Vanguardfan December 1, 2019, 11:21 pm

    @naeclue I’m not sure your calculation re the DC LTA charge is correct.
    The LTA charge of 25% would, I think, reduce the size of the drawdown pot and not the PCLS (assuming you hadn’t had more than £100k as tax free lump sum when taking the DB, in your example there is no PCLS for the DB) I’m not sure about that though, this is pretty much at the limits of my technical understanding.
    I’m sure there are situations where you get more money by crystallising the DC first, but I think that’s down to the inherent uncertainties in DC growth vs the known quantity of the DB. Since the DB is guaranteed, index linked and with a guaranteed spouses pension, I’d rather maximise that element.

  • 63 Naeclue December 1, 2019, 11:23 pm

    @pingpong, if you can invest the tax free cash free of taxes by using the allowances it does not matter when you crystallise, apart from the fact that at the time you crystallise is brought into your estate and so in line for inheritance tax. So there is not necessarily any financial advantage in waiting to hit 100% LTA. Crystallise before you exceed 100% though, otherwise you start eating into the 25% tax free cash.

  • 64 Naeclue December 2, 2019, 1:29 am

    @Vanguardfan, the maximum pension lump sum you can take is 25% of your remaining LTA. So if the remaining LTA is 400k, because 600k DB has been taken, the maximum LTA is 100k.

  • 65 Naeclue December 2, 2019, 1:31 am

    Sorry meant to end maximum PCLS is 100k.

  • 66 Pingpong December 2, 2019, 8:49 am

    @Naeclue Interesting analysis of DB versus DC first. The other key decision driver will be health in old age and how far you forecast living beyond 85. As Vanguardfan says in early post you are at risk of overpaying the 25% tax charge if you live beyond 85.
    ( ie Essentially if I take it from the DB then I pay 1/20 of the 25% tax charge every year, so if my pension is in payment for longer than 20 years I would end up paying more than if I paid the 25% charge from a DC pot put into drawdown).
    With regards to timing my crystallisation of the DC fund I am trying to maximise the valuation of my DC fund at BCE5 as it does not attract inheritance tax being in a pension discretionary fund. When I drawdown the 25% tax free portion from the DC I have a burden of trying to get this off my estate so it does not attract inheritance tax. This could be achieved by setting up discretionary trust but there is an additional cost burden of administration costs of running this trust. Or I could gift it away to the younger pingpongs but lose any opportunity of it growing in value in a tax free wrapper for intergenerational benefit.

  • 67 Vanguardfan December 2, 2019, 9:00 am

    @naeclue, that’s the bit I’m not sure about. I know you can only take 25% of the LTA as tax free cash in total, but I’m not sure that it would be limited to 25% of the remaining LTA if you hadn’t taken tax free cash with the DB.

    But hey, first world problems indeed, and I’m not losing any sleep.

  • 68 Pingpong December 2, 2019, 9:52 am

    @Vanguard/Naeclue. I would also be interested to know if you don’t take any cash lump sum when crystallising your DB first does that have a detrimental effect on your ability to draw 25% of the LTA ( ie 25% of 1.055M ) from your DC at a later stage. Also if your DC then subsequently exceeds the LTA limit (and you fail to take a cash lump sum prior to the breach) does that similarly have a detrimental effect on your ability to draw the full 25% of the LTA.

  • 69 Vanguardfan December 2, 2019, 11:10 am

    @pingpong. You can’t draw more than 25% of the DC pot, I’m sure of that – ie you can’t transfer ‘unused’ tax free cash from the DB to the DC (sometimes you can do this with a linked DB/AVC arrangement with some private sector DB schemes, but not with separate pensions). The question is, in naeclue’s example, could 25% of the 600k DC pot still be taken?

    In your case ping pong, I think you can afford to be relaxed about breaching the LTA. If the alternative is going to be 40% IHT, then a 25% LTA charge is clearly still tax efficient (if your heirs take the pension as income).
    My view is that tax rules can and will change, especially over the long time horizons we are (hopefully) talking about. So for myself I don’t think it’s worth spending a lot of time and energy on future tax optimisation which relies on today’s situation, as that will not be tomorrow’s situation.
    I am also more relaxed than most about tax – it’s almost always better to have a taxed asset than not to have the asset at all – so a tax bill can be viewed as a positive indicator. (I do take the obvious actions to reduce easily avoidable taxes in the present, like using ISA and pension allowances).

  • 70 Naeclue December 2, 2019, 11:26 am

    @Vanguardfan , take a look at this page from the tax manual https://www.gov.uk/hmrc-internal-manuals/pensions-tax-manual/ptm063230

    “The permitted maximum is defined in the legislation as being the lower of two amounts. These are:

    – the available portion of the member’s lump sum allowance, and
    – the applicable amount.

    In broad terms the available portion of the member’s lump sum allowance is an amount equal to 25% of the member’s lifetime allowance available when the lump sum crystallises.

    In broad terms the applicable amount represents 25% of the capital value of the benefits coming into payment under the relevant arrangements under the scheme generating the lump sum payment, but ignoring any disqualifying pension credit held.”

  • 71 Vanguardfan December 2, 2019, 11:37 am

    Thanks naeclue, that is pretty clear then. (Doesn’t change my own preference though, as my DC is much smaller in value than the DB and I’m not too bothered about wringing out the last bit of tax free cash. If I even go over the LTA which is not by any means certain).

  • 72 Naeclue December 2, 2019, 11:44 am

    @pingpong, my interpretation of the rules is that on crystallisation you can take the lower of

    – 25% of the amount of crystallisation at the time of crystallisation;
    – 25% of remaining LTA.

    If you take less the 25% at the time, you cannot take more than 25% at some other time.

    I think your logic on taking a 25% reduction in DC capital is better than 25% reduction in DB income is flawed by the way. Both DB and DC pensions produce an income stream, the DC stream is just more flexible. Taking 25% of the DC pot as a charge is equivalent to taking 25% from the income stream it produces. To think about it another way, were you to sell a £7,500 DB income stream, you would get exactly 75% less for it than if you were to sell a £10,000 income stream.

  • 73 Vanguardfan December 2, 2019, 11:59 am

    Naeclue, I don’t disagree, but I would add that a DC pension is not ‘just’ more flexible, it’s also more risky. That means that its value will fluctuate in an uncertain and unknowable way, while the DB value is much more certain. I think this can cut both ways. A DC pot may end up being worth less, or more, depending on how investments perform.
    It does mean though that the sequencing decision is as much about psychology as about numbers (like pretty much all financial decisions).

  • 74 Naeclue December 2, 2019, 12:00 pm

    @pingpong, I see what you are trying to do with your DB income stream. Potential drawbacks I see are

    – the longer you leave the 25% PCLS in the DC fund, the bigger it gets (hopefully) and the higher the IHT risk when you eventually draw it. (The more likely it will be that you do not survive 7 years)
    – the longer you leave the PCLS before drawing it, the bigger the risk that you will not survive 7 years after giving it away and so be hit by IHT.

    You could maybe do partial crystallisations using UFPLS. Crystallise £12k per year. The £3000 can be given away as your annual allowance and the other £9k (minus tax) would qualify as gift from income provided you set up and documented the regular pattern, which could just be annually. Or just give away the £3k and leave the rest in drawdown.

  • 75 Naeclue December 2, 2019, 12:04 pm

    @vanguardfan. I agree. I think the decision comes down to personal circumstances and attitude to risk. As I said before, my preference would be the same as yours, to take the charge from the DC pension.

  • 76 Naeclue December 2, 2019, 12:17 pm

    As an example of how personal circumstances might feed in to a decision to take either £2,500 DB income stream or £50k tax free cash, the DB income is taxable and worth £2,000 to a basic rate payer, £1,500 to a higher rate payer. The £50k cash can potentially produce a tax free income stream through allowances and working into ISAs.

  • 77 Al Cam December 2, 2019, 2:42 pm

    @Vanguardfan. Are you referring to an active DB scheme or a deferred one? Apologies if this has already been clarified – but I did not see it.

  • 78 Brooke Rutherford December 6, 2019, 8:02 pm

    “A Day is the pension expert’s equivalent to the birth of Christ.” LOL. This is so confusing and one of the reasons I mentally write off my SIPP as an investment tool. I’m always confused about whether the lifetime allowance applies to ISAs?

  • 79 roger August 20, 2020, 2:25 pm

    when one claims Lifetime allowance Individual protection 2016 by submitting the value of all one’s pensions at April 2016 on the HMRC portal, how does HMRC check the values are correct and, if they are not correct (eg an over estimate), is there any penalty?

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