For professional advisers only

Choosing to exceed the LTA

Ian Linden, Pensions Manager February 2019

Would you?

Contents

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The technical aspects

Case studies

1

2

Summary 3

The technical aspects

• No limit on the total amount of authorised benefits a registered pension

scheme can provide to its members.

• The LTA simply limits the value of tax-privileged benefits the individual can

draw from such schemes .

• The value of any authorised benefits paid out in excess of their allowance is

subject to a tax charge known as the lifetime allowance charge.

What is the lifetime allowance (LTA)

4

Technical aspects

• Standard lifetime allowance (SLA) reduced to £1m from 06/04/16

◦ Indexed by CPI from 06/04/18

◦ Current SLA of £1.055m having increased from £1.03m on 6 April 2019

• Fixed protection 2016

◦ Personal LTA of £1.25m

• Individual protection 2016

◦ Personal LTA = value of pension rights at 05/04/16

Rights > £1m at 05/04/16

Maximum personal LTA = £1.25m

What is the lifetime allowance

5

Technical aspects

There are two circumstances where a lifetime allowance (LTA) charge arises

following a benefit crystallisation event (BCE):

• Where the amount crystallised at a BCE exceeds the available amount of

the individual’s LTA. The charge arises on the amount above the available

LTA.

• Where a BCE occurs and the individual has no remaining LTA available.

The charge arises on the whole amount crystallised at that event.

BCEs can only occur before or on an individual’s 75th birthday (with the

exception of a BCE 3).

When does an LTA charge apply

6

Technical aspects

• The chargeable amount is the amount that crystallises for LTA purposes

that exceeds the individual’s available LTA at that point.

• An LTA charge arises on this chargeable amount, the aim of which is to

negate the tax reliefs the funds have benefited from over the years.

• The amount crystallising at the BCE that is not covered by the available LTA

is referred to as the ‘basic amount’ of the chargeable amount.

• The chargeable amount is always the gross value of the benefits that

exceeds the individual’s available LTA, namely pre any tax deducted.

How does the LTA charge work

7

Technical aspects

• The lifetime allowance charge is levied at one of two rates:

◦ 55 per cent following the payment of a relevant lump sum or relevant

lump sum death benefit

◦ 25 per cent for any part of the chargeable amount not derived from a

lump sum payment and therefore retained within the scheme, or an

overseas scheme

• Original premise was that either option financially neutral

Which rate of tax applies

8

Technical aspects

Case studies

Rio, aged 70, is retired with no remaining LTA. He still has £200,000 in

uncrystallised funds in his Sipp.

He is a basic rate taxpayer with taxable income of £30,000 in the current year

and so has headroom of £16,350 before being subject to HRT.

Rio needs to realise around £10,000 to carry out some work in his home and

is considering taking the capital from his uncrystallised funds.

Scenario

10

Case study 1

• Option1 – lifetime allowance excess lump sum

◦ Amount crystallised - £22,222, LTA charge at 55%

◦ Net amount - £9,999.90

• Option 2 – retained amount

◦ Amount crystallised - £16,666, LTA charge at 25%

◦ Drawdown payment subject to income tax at 20% - £12,499.50

◦ Net amount – £9,999.60

◦ Effective rate of tax of 40%

Which rate of tax applies

11

Case study 1

In 2016 Jameelah planned to retire on 6 April 2021. At that time she earned

£120,000 per annum and paid £20,000 p.a. into her pension at the beginning

of each tax year. She still earns this amount and has no other source of

income. Her fund was worth £850,000 at 5 April 2016 and so she opted to

cease contributions and applied for Fixed Protection 2016 (FP 16).

• Considerations

◦ Relying on FP 16

Net savings of £8,000 invested in ISA

◦ What if she had opted instead to remain a contributing member?

Scenario

12

Case study 2

• Additional income tax of £12,000 paid p.a.

◦ Looses part of personal allowance (PA) as income option taken

Loss of PA + tax, equivalent of up to 60%

• For simplicity, no increase in salary, tax bands, etc. over period

◦ 5% investment return

◦ LTA increases by CPI each year (£1.0977m in 2021/22)

CPI = 2%

• Maximum PCLS taken when funds fully crystallised

• Excess over LTA retained in pension

◦ Retained amount tax charge @ 25%

Assumptions

13

Case study 2

Outcomes

Case study 2

14

FP 16 What if!

Original fund £850,000 £850,000

Contributions plus

growth

— £350,878

SIPP value at

retirement

£1,084,839 £1,200,878

Lifetime allowance £1,250,000 £1,097,700

Retained amount tax

charge

— £25,794

Outcomes - Benefits

Case study 2

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FP 16 What if!

PCLS £271,210 £274,425

Drawdown fund £813,629 £900,659

ISA savings £46,415 —

• Under FP 16 option drawdown fund is £87,030 lower

◦ But £43,200 ISA fund (ISA fund less differential in higher PCLS under

What if)

• Slightly in favour of remaining a contributing member

◦ £60,000 of additional income tax paid under FP 16 option

Fiona is a widow with two adult children. Her net income for the last three

years was £170,000 (AA £30,000). She started a new job on 6 April 2019 on a

salary of £200,000. Her new employer makes contributions to staff pensions

equivalent to 15% of salary at the beginning of the tax year.

Neither Fiona nor her previous employer made any pension contributions

after 5 April 2016 as she was concerned about the LTA. She successfully

applied for Fixed Protection 2016, giving her a personal lifetime allowance of

£1.25m.

Her fund was originally worth £800,000 at 5 April 2016 and at 5th April 2019

was worth £ 926,100. She will retire in seven years on her 60th birthday which

is on 6 April 2026.

If she declined her new employer’s pension contributions, the company would

not increase her salary.

She fully funds her ISA each year, and her estate is liable to IHT.

Scenario

16

Case study 3

• Rely on fixed protection 2016

◦ Refuse funding of pension

• Accept ER pension funding and lose FP 16

◦ £30,000 p.a. indexed ER contribution

Choices

17

Case study 3

• Fiona would be impacted by tapering of the AA with a £15,000 AA

◦ ER contribution reduces this to £10,000

• For simplicity,

◦ Salary increases by 2% p.a.

◦ no increase in tax bands, etc. over 7 year period

◦ 5% investment return

◦ LTA increases by CPI each year (£1.055m in 2019/20, )

CPI = 3% (£1,293,700 in 2026/27)

◦ Liability for AA charge met on 6 April each year where appropriate

• Maximum PCLS taken when funds fully crystallised

• Excess over LTA retained in pension

Assumptions

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Case study 3

Outcomes

Case study 3

19

FP 16 Contribute

MP

Contribute

SP

Fund @ 05/04/19 £926,100 £926,100 £926,100

Contributions plus

growth

- £648,351 £604,198

SIPP value at

retirement

£1,303,116 £1,574,451

£1,530,298

Lifetime allowance £1,293,700 £1,293,700 £1,293,700

Retained amount tax

charge

£2,354 £70,187 £59,149

MP – member pays AA charge personally; total of £41,047

SP – scheme pays AA charge

Benefits

Case study 3

20

Option FP 16 Contribute

MP

Contribute

SP

PCLS £323,425 £323,425

£323,425

Drawdown fund £977,337 £1,180,839 £1,147,724

• Do numbers suggest she should re-engage with her pension and have

scheme pay AA charge (total of £41,047) on a voluntary basis?

◦ Member paying AA charge is out of net income (£74,631 gross)

◦ However, if estate is liable to IHT, removing assets, i.e., the AA charge

element, from her estate saves tax at 40% on the £41,047

Robert has just turned seventy and is an additional rate taxpayer. He has just

crystallised the excess of £200,000 over his LTA in his Sipp.

His intention is to make gifts to his two adult children.

Unfortunately he dies shortly after crystallising the funds.

He is a widower and his estate will be subject to IHT.

Consider two alternative approaches:

• Approach 1 - he did not manage to pay the net amount of the lump sum to

his son and daughter

• Approach 2 – he had only paid each of them £10,000 from surplus income

Scenario

21

Case study 4

Outcomes

Case study 4

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Amount LTA tax

charge

Income

tax

charge

IHT tax

liability

Effective

net fund*

Effective

tax rate

Lump

Sum

£200,000 £110,000 n/a £36,000 £54,000 73%

Drawdown £200,000 £50,000 £16,364 £8,000** £125,636 37.18%

*Effective net fund reflects remaining value after all taxes and in second scenario

adding back residual income held by the children

** If there was evidence in writing that the individual intended to make the payments out

of excess income on a regular basis, HMRC might not factor in the initial payments for

IHT purposes, therefore giving an effective rate of tax of 33.18%

Presume Robert doesn’t die as in the first two approaches and adopts a

different strategy.

• Approach 3 - invests the excess lump sum in an ISA each year over a five

year period and then lives a further ten years

• Approach 4 – retains the net fund in drawdown – same time scale as in 3

No income or capital is taken either from the ISA or drawdown fund with annualised

investment returns of 5% for the ISA and pension, with 1% for holding the balance of

the lump sum in cash until investment in the ISA. The ISA subscription each year is

£20,000 with a balance of £11,634 paid in the final year.

Scenario - alternative

23

Case study 4

Outcomes

Case study 4

24

Net after

LTA

charge

Value at

75

Net after

LTA

charge

Value at

85

Net after

IHT at

40%

Net after

income

tax at

45%

Lump

Sum

£90,000 £107,254 n/a £174,705 £104,823 n/a

Drawdown £150,000 £191,442 £181,081 £294,961 n/a £162,229

• Beneficiaries take full excess drawdown fund as an income

◦ Taxed at 45%, but still 54.7% more than having inherited the ISA monies

• Extract income from the drawdown funds at 20%

◦ net fund after all taxes would be equivalent to £235,968 (assuming no further

growth) or £131,145 more than was left from the ISA.

Summary

1. Technical aspects

◦ What is the lifetime allowance (LTA)

◦ When does an LTA charge apply

◦ How does the LTA charge work

◦ Which rate of tax applies

2. Case studies

◦ Rio – lump sum or drawdown

◦ Jameelah – FP 16 or what if

◦ Karen - FP 16 or restart funding pension

◦ Robert – decisions, decisions, decisions!

26

Summary

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