Pensions may still be the best place for savings, even if you have reached your Lifetime Allowance (LTA). But confusion over contribution allowance may result in pension funding being switched off!
‘Allowance’ is the key here; it is not a ‘limit’
The latest in our “Mythbusters” series looks at some of the commonly held Lifetime Allowance misconceptions, and busts them!
Myth 1 – Contributions must stop when I reach the LTA
Not True! There is nothing to prevent you from continuing to contribute to your pension scheme. You still have an annual allowance of £40,000 available (if not reduced for high earners), allowing you (or your employer) to make contributions and get tax relief at the highest marginal rates. The LTA is not a barrier to pension saving or the growth on your investment; it is the point where you look at what the likely tax treatment of this additional fund will mean for you. This is no different to any other allowance (e.g. the personal income tax allowance or annual capital gains tax allowance) once it is breached then tax will be applied.
Equally as important (for employees) is if funding is stopped. There may be no alternative form of remuneration on offer to replace the employer pension contribution; this can really strengthen the argument to continue with funding.
And don’t forget; where an employer does offer alternative remuneration, this is fully taxable and the amount available to invest will be subject to income tax and National Insurance.
Myth 2 – There is a tax charge to pay as soon as I reach the LTA
Not True! When you hit the LTA with your fund there is no immediate penalty. You just have a fund larger than the amount the allowance protects. The tax charge is only incurred when benefits are crystallised, such as when the fund is designated for drawdown.
Myth 3 – The LTA tax charge is applied when I start taking benefits
Not True! Benefits are tested when they vest; a process referred to as crystallisation. The charge is only applied when there isn’t enough LTA to cover the fund (that is being crystallised). Each time you crystallise (some of your pension) a percentage of the LTA is used, but the charge itself only comes into play when you no longer have enough LTA to cover the amount being crystallised.
By phasing your retirement and only crystallising enough funds as are needed each year, this means that the timing of the LTA charge can be managed, at least until you are 75. At this point any uncrystallised funds will be tested (along with any investment growth on crystallised funds). When funds over the allowance are going to be accessed – will that be during their lifetime or after their death? These considerations will help to predict the potential tax charge on excess funds.
Myth 4 – The penalty for exceeding the LTA is 55%
Not Always! The charge of 55% is only payable if the whole of the chargeable amount is taken as a lump sum. If you move it to your drawdown pot, only 25% will be deducted (don’t forget there is no tax free cash element). This would be beneficial if the income tax then applied when withdrawing an income is less than 40%, which will be the case for many of those in retirement who are able to control the level of their taxable income from effective management of tax allowances.
Myth 5 – On death there will be another LTA test on funds in drawdown
Not True! There is not a 2nd LTA test on death for crystallised funds. So, if you die before you are 75, your beneficiaries will be able to inherit the pot without any further LTA charges. And, income they take will be tax free so the only cost incurred was the 25% LTA charge when it was originally put into drawdown.
If you die after age 75, then your beneficiaries would pay income tax at their own rates on the amounts drawn. So, depending on their (your beneficieries) other income, this could potentially be only subject to basic rate tax, or even covered by their own personal allowance.
Ultimately, having a fund approaching the LTA does not mean that pension saving has to cease. A considered approach can show that there may still be reasons to continue funding depending on your circumstances. And remember from April 2018 the LTA will become inflation linked so it won’t remain £1M forever.
For help with your Retirement click here or call Active on 01642 765957.
The content of this blog is for information only and must not be considered as financial advice. We always recommend that you seek independent financial advice before making any financial decisions.
Levels, bases of and reliefs from taxation may be subject to change.