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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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{ 77 comments… add one }
  • 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.

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