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 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.
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.
Individual protection 2016
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.
Fixed protection 2016
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.
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