Even though you may be retired and receiving your pension, everyone is still subject to pension lifetime allowance test at age 75.
The lifetime allowance tax charge can be significant, potentially resulting in a big dent in your pension funds.
It’s important to understand what it is so that with the right planning, you can avoid it if that is in fact the best action to take.
The lifetime allowance test at age 75
The lifetime allowance was introduced on the 6th April 2006 and the original allowance was £1.5 million. By the 6th April 2011 the allowance had risen to £1.8 million but has since been cut significantly.
The current lifetime allowance as at March 2021 is £1,073,100. Having been increased by inflation over the last few years it will now remain at this level until the 2025/26 tax year. A very sneaky stealth tax implemented by the Chancellor at the last Budget.
The lifetime allowance is the total amount you can hold in pensions without facing the lifetime allowance tax charge.
The lifetime allowance does not apply to the State Pension but does include all other personal and workplace pensions.
When trying to understand your current position:
- Add up the value of all of your defined contribution pensions.
- For defined benefit (final salary) pensions take the projected income per annum and multiply it by 20 and add any lump sums. Then add this value to your other ‘pots’.
If you find the combined value of all your pensions is above the current lifetime allowance then you don’t face a tax charge straight away. You only face a potential tax charge at the point you decide to take some money out of a pension.
At the point you take money out a lifetime allowance test is carried out to see if you have breached the limit. The test is only done on the funds used to create your withdrawal.
Let’s look at a couple of examples:
Robin has a Self Invested Personal Pension (SIPP) worth £1 million. At age 60 he is still working but decides he would like to take his tax free cash lump out so he can purchase an investment property.
He is entitled to withdraw up to 25% of his fund (£250,000) tax free. He doesn’t need the remaining 75% (£750,000) so this is left invested in a drawdown account.
In order to withdraw the £250,000 Robin must crystallise his entire pension fund. Therefore his entire £1 million SIPP is tested against the lifetime allowance. As the value (£1 million) is below the current lifetime allowance (£1,073,100) there is no tax charge at this time.
Jessica, aged 66 is retired and receiving a £40,000 per annum defined benefit pension from her previous employer. She also has a SIPP worth £400,000.
She decides to withdraw her 25% tax free lump (£100,000) from her SIPP to gift to her daughter to help her buy her first home.
Her defined benefit pension value for lifetime allowance purposes is £800,000 (20 x £40,000) therefore she has already used 74.6% of her lifetime allowance (£800,000 / £1,073,100).
Jessica has £273,100 of her lifetime allowance left.
As Jessica wants her entire tax free lump sum from her SIPP she needs to crystallise the whole £400,000.
The £400,000 is tested against her remaining lifetime allowance (£273,100) which means she is £126,900 over the allowance and therefore subject to a tax charge.
The lifetime allowance tax charge will be either 55% or 25% depending on how the excess is taken.
- 55% if taken as a lump sum.
- 25% if taken as income.
Unfortunately for Robin and Jessica their lifetime allowance calculations are not done. There will be another lifetime allowance test at age 75.
What this means is that if Robin’s or Jessica’s remaining funds in drawdown have grown then they could still be subject to a tax charge at age 75.
In Robin’s case, having previously crystallised everything and been under the lifetime allowance, using up 93% of it, if by the time he was 75 his drawdown fund had grown to £950,000 he would face a lifetime allowance test at age 75.
The growth in his drawdown funds (£200,000) would be tested against his remaining lifetime allowance of £75,117 (7% of £1,073,100) which now means £124,883 (£200,000 – £75,117) is subject to a tax charge.
Planning for the lifetime allowance test at age 75
If you are planning to use drawdown as the method of taking money out of your pension then there are essentially 3 ways to avoid the lifetime allowance test at age 75.
#1 – Use lifetime allowance protection to increase your lifetime allowance
There are two types of lifetime allowance protection that can still be applied for.
Can protect your lifetime allowance at the lower of:
- Your total pension value at 6th April 2016 or
- £1.25 million.
You can continue to contribute to pensions.
Fixes your lifetime allowance protection at £1.25 million.
No pension contributions can have been made by you or any employer since 6th April 2016.
#2 – Keep investment growth low
If your total current pension value is below the lifetime allowance then you could opt for a very low investment growth option that ensures your pension doesn’t really grow and therefore stays under the lifetime allowance.
Of course you would be missing out on future investment growth. Remember it’s only the excess above the lifetime allowance that is taxed. So if your funds do grow from good investment performance it just means you get less of this growth after tax.
#3 – Make pension withdrawals
You could continue to make withdrawals from funds already in drawdown to ensure the value remains below the original amount designated into drawdown.
You need to factor in your Income Tax position as funds withdrawn will likely face some form of Income Tax.
Also, a pension is now a very good way to shield assets from Inheritance Tax as pensions are not subject to Inheritance Tax.
So again, you need to balance the risk of paying a lifetime allowance tax charge with a potential Inheritance Tax charge.
By focusing on the lifetime allowance test at age 75 there is a danger you focus on the tax too much and forget about what you are trying to achieve in retirement, which hopefully is a sustained income that allows you to live the life you want.
You just need to be aware of all the facts, have a flexible retirement plan that can adapt and ensure you regularly review your options.
This will be your first retirement, but for us, we have done it hundreds of times. So please get in touch for a no obligation, free 15-minute conversation so we can help you understand your lifetime allowance position, where you stand and what you need to do next.
Stock market linked investments and any income from them, can fall as well as rise and is not guaranteed. Any figures quoted are for illustrative purposes and should not be taken as a forecast or guarantee. Past performance should not be seen as an indication of future returns and clients may get back less than they have invested.