From the Bellpenny Nest
Protecting your pension pot couldn’t be more important in recent times following the government’s decision last year to reduce the Lifetime Allowance (LTA*) to £1 million. Although funds within your pension pot can grow tax-free, the limit means that the total amount you can save before you suffer a penalty charge has been reduced.
The rules surrounding the LTA can be complex and some people aren’t aware that once they reach age 75 they must be re-tested against the LTA limit.
To put this into context, imagine you are now over age 55 and you have saved hard for your retirement. You decide you want to start drawing on some or all of your pension benefits to enjoy the retirement you deserve.
You discuss your options with your Bellpenny Financial Planner, and decide to take full advantage of the new pension freedoms so, instead of using some or all of your accumulated pension fund to buy an annuity, you set up a ‘flexi-access drawdown account’.
Your Planner informs you that accessing your pension benefits in this way is a ‘benefit crystallisation event’; hence the value of your pension fund will be tested against your LTA. But not to worry, the value of your pension fund is at, or below, your Lifetime Allowance so there will be no Lifetime Allowance Charge**.
The good news is that you are now safe in the knowledge that the only tax you will ever have to pay on your drawdown fund is income tax on the amount you withdraw, in excess of your 25% tax-free cash allowance, for as long as you live. Unfortunately you’d be wrong, and let us tell you why.
Whilst the pension freedoms, introduced with effect from April 2015, removed the previous age 75 limit for pension drawdown, it is probably less than well known that any funds still held within a drawdown account at age 75 must be tested again against the prevailing LTA at the time (even if an Annual Allowance Charge was incurred the first time round).
Fortunately, it is only the net growth on your fund that will be tested (i.e. the investment growth achieved on the amount you originally ‘crystallised’ less the income payments you have received). So for most people this will not be a problem, but if the amount you first designate into drawdown is at or close to your Lifetime Allowance you could end up with an Annual Allowance charge as an unwelcome 75th birthday present.
This situation could easily arise if you are prudent with your regular income withdrawals and/or if you are fortunate in your investment returns, particularly if, as part of your sound estate planning, you decide to use your other savings and investments first to meet most of your regular income needs (in order to preserve the value of your flexi-access drawdown account for future generations).
At this point it is also worth noting that the tax status of funds held within a flexi-access drawdown account changes on death after reaching age 75. In particular, whereas on death before age 75 the payment of a lump sum or a ‘Beneficiary’s Flexi-access Drawdown Pension’ to your nominated beneficiaries would be completely tax-free, on death after age 75 the same payments would be subject to income tax at the recipient’s highest marginal rate.
With age discrimination a continuing problem in pensions, there is clearly a need for on-going professional advice.
If you would like to know more please speak to your Bellpenny Financial Planner and call 0345 475 7500.
* The Lifetime Allowance is the overall ceiling on the amount of tax privileged pension savings that any one individual can draw from registered pension schemes. The exact figure will be whatever the 'standard Lifetime Allowance' is for the tax year concerned or the protected amount if greater. The standard Lifetime Allowance for 2017/18 is £1 million.
** The Lifetime Allowance Charge is the tax payable on registered scheme benefits crystallised in excess of the prevailing Lifetime Allowance. The Lifetime Allowance Charge for 2017/18 on lump sum payments is 55%
Please Note: this article is for information purposes only. It is not financial advice. The information is based on our understanding of current and proposed legislation as at April 2017, which is subject to change.