The Lifetime Allowance

When I started this blog I didn’t have a set target in mind about what I wanted to write. The result is that I’ve written about all sorts of subjects from why Mrs YFG and I don’t want kids through to the technicalities in Safe Withdrawal Rates.

I enjoy writing about FI and various tangential subjects. But I’ve also really enjoyed writing about personal finance subjects. I like to learn about something, try to understand it and then have a go as explaining it in (hopefully) a concise and easy to understand way.

The most popular post on the blog so far has been on the State Pension and NI-top. Like a moth to flame, I’m continually attracted to writing about pensions. I think that’s because Pensions can be inherently complicated and finding good material on the subject is challenging. It’s also because there are some misconceptions and I want to challenge those.

Today’s subject, the Lifetime Allowance, seems to tick all three boxes. Lets start with a quick introduction.

What the Lifetime Allowance is and why it exists

The Lifetime Allowance (LTA) for 2018/19 is £1.03 million. Basically what happens is if your total pensions are greater than £1.03 million, you will get a 55% tax charge on any lump sums you take or 25% on any pension income you take (more on all that in a bit).

When you put money into a pension the Government provides tax-relief. For example, if you earn £80,000 a year you will be a 40% tax-rate payer. If you put £600 into your pension out of taxed income the government will put in £400 (40% of the total contribution) to bring you up to £1,000.

The underlying principle under the pension tax-relief system is that you defer taxes. Whilst pensions can be used to avoid taxation, generally speaking, what happens is that paying tax “going in” you pay tax later on when you draw on your pension.

It’s this principle which the lifetime allowance is balanced on. In effect, the Government is saying it isn’t in the business of giving rich people unlimited tax deferral benefits. So they created the LTA, a limit to the amount of tax deferral the Government is willing to give you.

History of the Lifetime Allowance

The Lifetime Allowance came into existence on 6 April 2006, known to those in the pensions industry as A Day. A Day is the Pension expert’s equivalent to the birth of Christ – things are either pre-A Day or post-A Day.

Essentially what happened on A Day was that a huge raft of disparate measures and rules were scrapped with new simplified rules coming into force. More than 8 different regimes were boiled down into two: the Lifetime Allowance and the Annual Allowance (more on that another time).

The starting LTA was £1.5 million. It crept up to £1.8m in 2010/11 before being drastically cut down.The 2018 budget provided some light relief, the LTA was increased by CPI (3%). However, the Government has no written commitment to continue increasing the LTA by CPI.

Protection mechanisms were introduced at each reduction in the LTA (including introduction): in 2006, 2012, 2014 and 2016. More on that in a bit.

When is the Lifetime Allowance assessed

The most important thing to remember about the LTA is that it is not assessed when you have a pension pot above £1.03 million. Rather, the LTA is assessed at specific points when you interact with your pension. These are called Benefit Crystallisation Events. There are 12 of them in total. But I’m going to focus on the 6 main ones (and Pre-A day interaction).

A few comments on the table above:

  • You can see a disconnect between how DB and DC schemes are measured. DB (BCE2) at 20 x annual pension; DC at the Annuity purchase price (BCE4) or Drawdown value (BCE1). With annuity rates at very low rates, its possible that were somebody to transfer from a DB to DC scheme that they could end up the wrong side of the LTA and incur a tax charge they may not have done if they’d stayed in their DB scheme (more on that later).
  • A similar situation exists for the QROPS transfer (BCE8) which is measured at Transfer Value. Bear in mind that since 9/03/2017 (retrospectively) QROPS transfers outside the EU incur a 25% tax charge.
  • Pre-A day pots are measured at 25 times pension or max capped drawdown. This is to account for tax-free cash taken. Pre-A day pots are measured when the 1st post A-day BCE occurs (such as, reaching 75 (BCE 5a) with a drawdown pot post A-day).

How the charge is assessed

In effect the charge is assessed by adding up all your pensions and “filling up” the LTA like a bucket. You only get a charge if the bucket starts overflowing.

You can partly dictate the order in which you fill the bucket. By taking some pensions earlier/later you can reduce your LTA charge. For example, as DB schemes are more ‘generously’ assessed compared to a lifetime annuity, it might make sense to take lifetime annuities first if possible. A lot will depend on what an individual’s scheme rules will allow.

Another thing to note is that Drawdown pensions (except Pre-A Day pots) are tested against the LTA twice. The first test is BCE 1 when the funds are first designated and then again on either:

  • Scheme pension (BCE 2), or
  • Annuity Purchase (BCE 4), or
  • reaching age 75 (BCE 5A), or
  • on transfer to a QROPS (BCE 8).

To ensure there no double counting only the increase in funds crystallised under BCE 1 are tested at the second designation.

How the charge is applied

As mentioned above there are two tax-rates: 55% and 25%.  These are commonly called the “lump-sum” and “income” rates. Its perhaps easier to think about these instead as whether the money “leaves” or “stays” inside the pension tax reigme. For example, if you take a lump-sum on drawdown, it leaves the tax regime. The excess above the LTA is charged at 55%.  If you instead take an annuity income, you take a 25% tax charge on the excess above the LTA plus any income tax (note: QROPS transfers count as a 25% LTA charge).

You might think that 25% is lower than 55% so taking income is always better. But it depends on what income tax rate you’ll be at. As an example:

  • Take £100 lump-sum over LTA: £100 x (100% – 55%) = £45 after tax
  • Take £100 income over LTA:
    • 45% tax-rate: £100 x (100% – 25%) x (100% – 45%) = £41.25 after tax
    • 40% tax-rate: £100 x (100% – 25%) x (100% – 40%) = £45 after tax
    • 20% tax-rate: £100 x (100% – 25%) x (100% – 20%) = £60 after tax

As those being hit by the LTA are likely to be high earners (40% or even 45% tax rate), there’s probably little different in overall tax rate between lump-sum and income.

In terms of how it’s charged, usually the pension scheme will pay the charge: called a “Scheme Pays” arrangement. This is because schemes are joint and severally liable for the tax, so they like to make sure the tax is paid instead of HMRC being on their back.

Protection – always use protection?

As I mentioned earlier, HRMC provided “Protections” against the reductions in the LTA. They each work a little differently. And whether, and what, protection is right for you will depend on your circumstances.

2006 Primary

  • Brought in on A Day
  • Aimed at individuals who wanted to keep accruing or saving into pension and were over the LTA
  • Eligible if Pensions > £1.5m on A Day
  • Your LTA is enhanced by a Lifetime Allowance Enhancement Factor (LAEF) to get a ‘personal’ LTA (rounded up to 2 decimal places)
  • Can keep accruing/saving into pension
  • Underpinned by an LTA of £1.8m

Example calculation:

Pensions worth £1.8m.

LAEF = (£1.8m – £1.5m) / £1.5m = 0.2 LAEF

Personal LTA = £1.8m + 0.2 x £1.8m = £2.16 million

2006 Enhanced

  • Brought in on A Day
  • Aimed at individuals who had exceeded the 2006/2007 lifetime allowance of £1.5 million, or believed they might exceed the standard lifetime allowance in the future, and were willing to cease all future contributions or limit future accruals
  • Eligible at any pension value on A Day
  • “Unlimited” LTA
  • But no more accruing (above certain limits, roughly speaking no more than higher of 5% or RPI) or making further contributions into pension
  • Had to surrender “excess rights”

Fixed Protection at 2012, 2014 and 2016 (FP 2012 / FP 2014 / FP 2016)

  • Eligible for anyone without Primary, Enhanced or other Fixed Protection
  • Eligible at any pension value
  • Fixed LTA at:
    • £1.8 million – FP 2012 – must have applied by April 2012
    • £1.5 million – FP 2014 – must have applied by April 2014
    • £1.25 million – FP 2016 – still open for application
  • But no more accruing (above certain limits, roughly speaking no more than higher of 5% or RPI) or making further contributions into pension

Individual Protection 2014 and 2016 (IP 2014 / IP 2016)

  • Eligible if:
    • Pensions > £1.25 million on 5 April 2014 (IP 2014) – must have applied by April 2017
    • Pensions > £1 million on 5 April 2016 (IP 2016) – still open for application
    • Anyone who doesn’t already have Primary Protection
  • Receive a capped and fixed Personal LTA equal to pensions value at 5 April 2014 /2016 up to:
    • Maximum of £1.5 million – IP 2014
    • Maximum of £1.25 million – IP 2016
  • Can keep saving into pensions or accruing

Valuing the benefits

To get the Pensions value for Individual Protection (and Primary Protection) you had to value each pension depending on its type:

  1. Unvested Schemes (i.e. not yet paying):
    1. Money Purchase – at market value of funds
    2. Defined Benefit – at 20 x pension plus any cash by addition
    3. Cash Balance – amount available for provision
  2. Vested Schemes (i.e. already in payment):
    1. Pre-A Day pensions – 25 x pension / Max GAD for capped drawdown at the first post-A Day BCE [*]
    2. Flexi Drawdown – 25 x Max GAD when Flexi Drawdown entered [*]
    3. Post A day vestings – value at BCE

[*] This is a bit complicated see Pru Adviser for more information: https://www.pruadviser.co.uk/knowledge-literature/knowledge-library/individual-protection-2014-2016/?advsr=4&advtsr=11&q=individual-protection

Losing Protections

Unfortunately it’s possible to lose protections after you’ve successfully applied for them. In some cases, it can be completely unintentional.

The good news is that Primary Protection and Individual Protections are almost impossible to lose. The only situation where an individual can lose the protection is if they were divorced and the pension was shared. In effect this reduces the level of protection on the pension. Under IP 2016 there is an offset mechanism which reduces the level of loss.

The bad news is that the rules are much more strict for Enhanced Protection and Fixed Protection.

An individual loses Enhanced Protection if they:

  • accrued a benefit which exceeds the permitted limit defined as the “relevant benefit accrual”;
  • contributed to a DC scheme (with some exceptions);
  • had a new arrangement (except in the case of certain transfers); or
  • made some transfers (HMRC has set of permissible and impermissible transfers).

The relevant benefit accrual depends on the scheme rules, statutory rates and the level of CPI each September. Generally speaking, it is very difficult to not exceed the limit if you an active scheme member.

An individual loses Fixed Protection if they:

  • increased their benefits in DB scheme above a certain level;
  • contributed to a DC scheme;
  • start a new arrangement under a registered pension scheme other than to accept a transfer of existing pension rights; or
  • transferred to an unregistered pension scheme (i.e. not a QROPS), from a DC to DB scheme (depending on circumstances) or from one DB scheme to another (again depending on circumstances).

An individual doesn’t lose Fixed Protection if they are subject to a pension debit (divorce). However, they will not be able to rebuild any pension fund without revoking their Fixed Protection.

DB to DC transfers – a word of warning

Generally speaking, DB to DC transfers are allowed under Enhanced and Fixed Protection. But the rights in the new scheme must be actuarially equivalent to the rights being transferred. As a word of warning for those with Enhanced or Fixed Protection, some schemes have been reported to offer transfer values out of DB schemes far in excess of their CETV (Cash Equivalent Transfer Value). Such transfers could result in the individual losing their protections. This is where seeking independent financial advice is very important.

LTA Planning – where paying more tax isn’t always a bad thing

If there’s one thing to take away from LTA planning it’s that:

Paying tax is only bad if it the net benefit isn’t worth it

To give an example, say Jane earns £50,000 and is a member of an employment scheme and the employer will contribute 10% to her scheme unless she opt-out. Here’s the maths:

Amount added to pension fund: £5,000

Lump sum after 55% tax: £2,250

Net cost as a 40% tax payer: £0

In this case, she’s getting £2,250 for free. Clearly a good deal!

 

Now say Jane’s employer will match 10% to 10%. The maths can still be good:

Amount added to pension fund: £10,000

Lump sum after 55% tax: £4,500

Net cost as a 40% tax payer: £3,000

So for £3,000 after tax she can get £4,500 in your pension. An immediate 50% return.

Now whether that will be the right call for her will depend on a few things. If she’s close to retiring, that 50% boost is difficult to beat. On the other hand, if there are ISAs or her spouses pension available then it might be less enticing. Likewise if accessing that money is a long way away. She’ll also want to consider whether she wants to pass on an inheritance to her children; in that respect, the recent inheritance tax changes to pensions can make it a very appealing option.

To round up, I quote Pru Adviser (which was a helpful source for this post):

The key point that clients need to remember is that tax is only bad if the net benefit is not deemed “worth it”. Opting out to save a tax charge, even if the net benefit is better, would be a bit like a client asking their employer to stop paying their salary because there is a tax charge.

In closing – key points

  • The underlying principle under the pension tax-relief system is that you defer taxes.
  • The LTA regime is a claw-back of this the tax deferral
  • The LTA is assessed at certain interactions with your pensions, called Benefit Crystallisation Events (BCEs)
  • How your total pension pot is valued depends on what type of pension it is
  • There are a number of protections to increase or fix your LTA, but you can lose them if you aren’t careful
  • Paying an LTA tax charge is only bad if the net benefit isn’t “worth it”

Please let me know your thoughts. Have you done any Lifetime Allowance Planning? Has the Lifetime Allowance changed what you do with your pensions?

Disclaimer: Please note, I’m not an FCA authorised financial adviser. The site provides information, comment and opinion for information purposes only and should not be considered financial advice. The site may contain incorrect information or mistakes. You should do your own research or speak to an authorised financial advisor or financial planner before making any and every investment decision. If you make an investment or decision on the basis of any information you do it at your own risk.

 

All the best,

Young FI Guy

Comments

  1. To answer the questions posed in your second-to-last paragraph, yes, and yes.

    In April 2016 I had almost exactly £1mm in DC pensions, on a glide path to £1.25mm, the then-LTA, and expected to hit in four years when I planned to retire.

    The April 2016 reduction in LTA from £1.25mm to £1mm would have cost me £63k in additional tax if I did not take out FP2016. However, after taking out FP2016 the complete loss of company pension contributions and salary sacrifice uplift meant an effective 25% reduction in future salary.

    As neither an extra £63k tax bill nor a 25% reduction in future salary appealed, I took FP2016 and simply retired four years earlier than planned.

    The problem here was not so much the presence of the LTA as it was the ‘step change’ in its level. A huge non-linearity that lead directly to a choice of two outcomes, neither of which was appealing when compared with simply giving up entirely on pension saving.

    So yes, I would say I have done considerable LTA planning. I have also pushed the lowest growth asset classes into my pension — bonds and gilts — and moved the (expected) faster growth assets such as stocks into my ISAs and taxable accounts. That way my pension will creep slightly more slowly towards its inevitable collision with the LTA.

    A particular problem is the second LTA test at age 75. The only way to defuse this is to draw down (taxable) all the pension growth after crystallising the pension. Not just real growth, but nominal too. Once crystallised at 100% of LTA, there is no inflation offset at all for the period up to age 75.

    Also worth noting that the various protection levels are themselves not indexed for inflation either, and so all of them will eventually become worthless as the ‘normal’ inflation linked LTA surpasses them. IP2016 at £1.03mm or lower is already worthless.

    1. Thanks for a great comment Anon. And thank you for sharing your own circumstances. It sounds like you have been quite savvy and done some sensible pensions planning.

      You raise some excellent points in your last two paragraphs. It’s worth adding some more to them.

      The drawdown test at age 75 can be easily forgotten. For those opting for a drawdown route, it is important to think about where their pension position is likely to be at age 75. That’s because, whilst there is the overlap test (as I mentioned in the post), as you quite rightly point out, the test is based on nominal not real growth. There’s no indexation. In that sense, it may make financial sense to draw income above the level you ‘need’ to ‘reduce’ the amount assessed at the age 75 BCE.

      The second point that is very important is that the protections are not indexed linked either. In that respect, they are designed to eventually become redundant. Once the LTA reaches a level higher than the protection, the protection is longer needed. As you point out IP2016 at £1m is already surpassed, though we aren’t quite up to the maximum of £1.25m yet. Bear in mind that the LTA isn’t guaranteed to increase with CPI. The government has made no statutory commitment to keep increasing the LTA. Savers are at the ‘good graces’ of the government for further LTA increases.

      A final thought – I completely agree with your comment: “The problem here was not so much the presence of the LTA as it was the ‘step change’ in its level. A huge non-linearity…”

      This is a problem I explored in the “State Pension – NI fiasco” post (link). Having these discontinuities creates distortions and unintended effects. One unintended consequence we’ve seen is that, like yourself, a number of individuals with large pension pots have called it quits (including many NHS doctors). There were issues when the 2014 LTA change came in, which really should have warned the government from any more step-changes. As I understand, the 2016 protections were a bit of a shambles as HMRC didn’t get their act into gear until well after the new LTA kicked in – protections had to be applied for retrospectively for a lot of people.

      1. Thanks for your note. Also for the entire article. I should have mentioned in my initial response that you have laid things out more completely, clearly and readably than just about any other article I have seen on this.

        As for FP2016 being a shambles… somewhat. Despite months of lead-up to the change, HMRC did not get the web page up and running for this until about three months after the April 2016 reduction. Quite why not is a bit of a mystery, since all it does is take in your name and NI number and then spit out a unique protection ID that is (presumably) stored somewhere inside HMRC. A summer intern could probably have completed it three days using 20 lines of PHP. Shrug.

        During the hiatus there was a temporary paper process in place. A bit fiddly, but overall I don’t think anyone was overly inconvenienced. You only had to use this if claiming protection and drawing on a pension during that period. I wasn’t, so all I had to do was wait for the three months and then apply.

        Brexit (grrr!) actually bumped up my pension, due to the fall in sterling. At the moment it looks like I will hit my protected LTA a year earlier than expected, but of course anything could still happen. It seems even clearer now, though, that taking FP2016 and retiring early was by far the most rational response to a completely irrational system.

        1. Thank you for the kind words Anon! I really appreciate the feedback (good or bad), as its a challenge to find the balance between brevity and being comprehensive. I’m pleased to hear that (at least for you) I’ve got the balance right.

          On FP2016, that’s exactly what happened. Perhaps I was being a bit guilty of being overly dramatic. I think it was more of an issue for DB schemes. Where they found lots of members suddenly over the LTA and at the same time were trying to put together bonus and salary packages for the new financial year.

  2. Thank you for your article. It’s going to take a couple of read throughs to fully understand that!

    I had a warning letter once about the possibility of exceeding my lifetime allowance – but I think that was on the understanding that I would retire at 65 and continue with my current level of contributions.

    Like anon, I expect neither of those to be true. I’m about to go part-time and will reduce my contributions accordingly and since I’m in my middle 40s – I expect to fully retire in my late 50s while enacting a slow decline in the number of hours worked until then.

    I wonder if the Govt’s intention was to encourage those with large pension pots to retire early!

    1. Hi greencat, thanks for reading and your comment.

      I had a warning letter once about the possibility of exceeding my lifetime allowance – but I think that was on the understanding that I would retire at 65 and continue with my current level of contributions.

      I think this is quite usual. All pension providers (and advisers) have to provide a pensions illustration which is meant to show you what’s gonna happen to your pension. These things make some almighty assumptions. If it’s possible the LTA might be on the horizon, your provider will warn you.

      Like anon, I expect neither of those to be true. I’m about to go part-time and will reduce my contributions accordingly and since I’m in my middle 40s – I expect to fully retire in my late 50s while enacting a slow decline in the number of hours worked until then.

      I wonder if the Govt’s intention was to encourage those with large pension pots to retire early!

      It sounds like you are following a similar path to a lot of people. Now I’m no conspiracy theorist, but if you’re not contributing into a pension, the Government doesn’t have to dish out money for the tax relief. Even if they are clawing that back from you down the line through the LTA or income tax, there’s still a net cash outflow for some time. The Government, particularly under Osborne, were quite fond of these tax/cash-timing wheezes. As far as I can tell the main reason for the LISA was turning the cash outlay around in the Treasury’s favour. So I certainly wouldn’t discount the possibility that slowing or stopping pension contributions might have been a factor in the decreases of the LTA.

  3. Ok so I have some difficulty working out whether it is better to keep on adding to pensions knowing that you are likely to exceed the LTA eventually. In the context of basic rate relief and no employer contribution.

    1. Hi Red Kite, thanks for commenting. You aren’t the first and certainly won’t be the last scratching their head at all this. I know the FI community are sceptical on the benefits of IFA’s and Financial Planners. But this is the kind of thing where a good planner can really help out. Of course, I understand that paying for an IFA or a Chartered Financial Planner isn’t going to be for everyone.

      I obviously can’t advise you what the right thing to do is. But here are some tips I find helpful when I’m thinking about my own finances:

      1. Think about where you’ll be if you keep doing what you’re doing (i.e. contributing to your pension). Will you cross the LTA? How much of a pot will you have and when and how can you access it?
      2. How much does it cost to get that pot? For taxes, will you be paying any LTA? If so, how much? What are the fees involved?
      3. Think about where you’ll be if you stop. What would you do instead? Would you contribute to an ISA? Use a spouses’ allowances? Buy property or other investments? What will you end up with if you stop?
      4. Then compare the two. Both quantitatively: what leaves you with the most money. And qualitatively: does stopping give you better access to your money? does stopping improve quality of life or does it create more hassle?

  4. Presumably we shall hear in due course about people who have been paying tax to cover contributions in excess of the Annual Allowance being hit again by tax for exceeding the LTA.

    There is another category I learned about recently. Young Fred had shown promise in his twenties. He then had a substantial promotion and became very well paid. In his twenties he hadn’t accumulated much by way of pension. In his thirties he can’t accumulate much because of his employer’s response to the annual allowance taper.

    Because of the uncertainties that the blog post alludes to concerning inflation and investment growth, it’s not even clear whether Young Fred has much to complain about. I suppose that the money he would otherwise have put into his pension will be spent on housing in London. Oh joy!

    1. Hi dearieme, the Annual Allowance is of course the left hand to the Lifetime Allowance’s right. It’s on my list to write about it. But I went for the LTA first as I feel a bit more positive towards the principles underlying the LTA than for the AA. I’m still a bit afraid I might get a bit ranty about the AA. And in particular, the taper which you mention.

      Without blabbing on to much, I’m a very much not a fan of the taper. And the situation your son(?) has found himself in isn’t surprising. The taper has been a big issue for lots of employers. Many have opted to “do away” with a lot of the hassle by reducing everyone to minimum allowance (£10k) rather than opening Pandora’s Box. Of course, a lot of the industry were warning that this would be the common-sense reaction to the policy…

  5. So glad we are living after A day and we are enjoying a ‘simpler’ system (sarcasm). Useful article – I hadn’t appreciated that there is a second test at 75 on drawdown funds. Thought I was reasonably well informed – have FP2016 and crystallised a DC pension to avoid exceeding the LTA. Have a few years before I really need to act and no doubt everything will have changed again by then. Really agree with earlier comment about step changes causing problems – pensions and pension planning needs long periods of stable regulations.

  6. What I can’t get from any online source is how long you have to keep paying the extra tax for. For example, if you have a 1.5M DC pension with no protections, do you pay the extra 25% tax on all drawdown payments until death? Until the pot size is below the LTA? Until the pot size is below LTA and you hit one of the test points?

    1. Hi Benjo, you only pay the tax on excess pension funds above £1.5m only at a Benefit Crystallisation Event (BCE). Taking money from a drawdown fund isn’t a BCE but allocating pension pots to drawdown is a BCE (i.e. saying your gonna use drawdown). Normally you only allocate for drawdown once, and you never you do it again. This BCE normally only occurs once at the start of drawdown. You won’t be assessed for the LTA until you reach another BCE, such as transferring out or when you reach 75.

      [edited to remove potentially confusing example, comments discussing example deleted]

  7. Hi, this is a really useful so thanks very much for writing it. I’m quite new to this and have struggled to get my head around it but I think I’m nearly there now. I do still have questions though…
    My assumption had been that if my DC pension got close to the 1M LTA limit I could effectively neutralise any future threat by:
    i) stopping any further pension contributions – and most probably retiring early.
    ii) sell enough funds to take out the maximum 25% cash lump sum (250k).
    iii) crystalise the rest by possibly allocating some to an annuity and what’s left over to drawdown.
    At this point I thought that 100% of my pension would have been assessed for LTA and any future growth of funds in drawdown would be immune.
    Is this correct or would I still need to worry about potential growth of the remaining drawdown fund for when I reach 75?

    1. Hi Humble Pie, thank you for commenting.

      Unfortunately, you need to think about the future growth of the drawdown fund. What happens is that on the first BCE (where you take the lump-sum (BCE6) and allocate to an annuity (BCE4) or drawdown(BCE6)) you get tested for how much of the LTA you used. Then when you come to the next BCE (on reaching 75 (BCE5a)) you’ll be tested on the LTA again. But, the amount you crystalised the first time around is deducted from that total. This is called the “Prevention of overlap for Drawdown Pensions”. But it means in effect you will be assessed on the growth of the drawdown fund.

      Here’s an example from HMRC (I’m reluctant to ‘come up’ with examples given the hassle last time):

      Andy is aged 55 and has benefits worth £200,000 held in a money purchase arrangement. On 5 August 2013 Andy draws all his benefits, taking a pension commencement lump sum of £50,000 and using the remaining funds to provide a drawdown pension.

      Two BCEs have occurred – BCE 1 for the designation of funds for a drawdown pension and BCE 6 for the provision of the pension commencement lump sum. A lifetime allowance test is triggered.

      The amount crystallised through BCE 1 is £150,000 (i.e. what becomes a drawdown pension fund at that point). The amount crystallising through BCE 6 is £50,000. The scheme administrator calculates that the benefits taken represent 13.33per cent of the standard lifetime allowance (£1.5 million for that tax year).

      On 5 August 2014, Andy decides to use all the drawdown pension fund to purchase a lifetime annuity contract. Andy has drawn very little drawdown pension and so his drawdown pension fund has grown to £180,000 at that time.

      A lifetime allowance test is triggered through BCE 4 when the annuity contract is purchased. The amount crystallised is reduced by £150,000 to reflect the amount that crystallised previously through BCE 1 when the funds were originally designated to provide drawdown pension.

      The amount crystallised is therefore only £30,000 (£180,000 – £150,000).

      (source: https://www.gov.uk/hmrc-internal-manuals/pensions-tax-manual/ptm088640)

      1. OK Thanks very much for the clarification – and the link to the hmrc manual which I’ve now spent a good few hours reading!

        So with that further information in mind I can add iv) to my above strategy:

        iv) Withdraw enough from my drawdown fund each year to ensure what’s remaining at 75 is less than the amount I started with.

  8. All I do with pensions is calculate the ‘effective’ relief on the way in and make sure it is > 55%. This is the case at the moment. I get matched contributions via salary sacrifice up to 6%. Then any additional salary sacrifice I make use of has the employer NI added on at 13.8%. Once I also factor in regaining the personal allowance for going under £100K in taxable salary I find that it makes a lot of sense to keep going because you actually get an ‘effective’ relief on the way in well in excess of 55%.

    The only reason not to do this would be if I needed access to the money before I am 55 (57 or 62 depending on which politicians you listen to). As I have access to capital elsewhere (for me this is in ISAs and a LTD company) then the lockup terms of a SIPP are not really an issue.

    The Annual Allowance (AA) and the Lifetime Allowance (LTA) exist because they have not tackled the elephant in the room, which is, quite simply, pension contributions are relieved of all taxes on the way in (income tax, employer NI, employee NI, corporation tax) and is a massive – well signposted – tax arbitrage.

    I’m bumping up around £1M and in my early forties but I will continue to put in £40K per year.

    The LTA needs to stay in it’s current form until I am 75, in more than 30 years time, when under current rules I am forced to take the tax charge for exceeding the LTA. It’s worth pointing out that this is the only Benefit Crystallisation Event I am forced to take, all others are at my own volition.

    Personally, I think it is very, very unlikely that the LTA will stay over the next 30 years. In the meantime, I can continue to get all the upfront relief in the intervening 30 year period on any contributions without having to worry about it.

    Whilst the LTA appears draconian, a 55% tax charge over 30 years if you receive just 40% income tax relief up front this year is an ad valorem tax charge of just 0.46% per year. That seems a very good deal for something that (a) rolls up tax free, (b) has zero reporting requirement for securities trades and (c) is likely to pass (after the LTA test at 75 and a 25% tax charge) to descendants, possibly to children, grandchildren or even great grandchildren.

    1. Hi Jon. Great comment. I like your simple way of thinking about it.

      I agree that the LTA and AA don’t really deal with the big elephant in the room. In an idealist world we would be measuring the level of tax-relief one has received throughout their lifetime and use that as a guide. But, practically speaking, that’s not going to happen because such records have not been kept. (Not to mention I just don’t believe HMRC would be capable of accurately calculating the right numbers, PAYE codes anyone?)

      I also agree with your last paragraph which is a nice take on the LTA. You could even add a point (d) which is by having the tax-relief up-front and taking it away at the end, you effectively get leverage on your investments.

    2. @JWB – haha nice one – I think that is the 1st comment I’ve read that suggests taking a punt on pensions because things may well get *better* rather than avoiding like the plague because things *could* get worse. I think you could well be right – if you believe in reversion to the mean then the AA and the LTA are both likely to rise substantially (they look incredibly stingey at the moment)

      I like your thinking!

      By the sounds of it you are in the *perfect* position salary wise and with the NIC situation to make hay while the sunshines?

  9. so what happens if your pension pot is valued at £1.3m and you pay the tax on £50k but it then goes down to £1.2m due to the stock market ? can you claim it back ?

      1. And if it then gets up to £1.3m again ??
        Basically if you get close you have to get into cash !

        1. If there’s another BCE and you get tested again, then any excess over the LTA will be charged. As mentioned in some of the above comments, it might be necessary to defuse growth to prevent getting an LTA on a second (or subsequent) BCE.

  10. The kicker is not the LTA at 55 for BCE1/BCE6 but what happens in the next 20 years. When I hit 55 in the very near future I project I will use 65% of LTA on BCE 1 and BCE6. Let’s say I don’t contribute anything more at that point and leave the drawdown untouched after taking the tax free cash. But with just 5% growth and the LTA increasing by 2.5% inflation the increase in the fund will be about 50% of the new LTA leaving me to pay 55% tax on around £250K for BCE5A aged 75. So as a result of the LTA I will retire at 55 and take out £11,850/annum.which along with the tax free cash which I can put in ISAs should keep me going for a few years.

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