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Where Taxpayers and Advisers Meet

Tax on Exceeding the Pension Lifetime Allowance

russ101
Posts:4
Joined:Tue Apr 19, 2011 6:24 pm
Tax on Exceeding the Pension Lifetime Allowance

Postby russ101 » Tue Jan 04, 2022 9:48 pm

I hope someone can provide the basic for me !

I'm already in receipt of a defined benefit annual company pension from which I took a maximum 25% tax free lump sum.

This pension took up 96% of my pension personal lifetime allowance.

The income from this pension places me in the 20% income tax bracket.

I also have a second deferred defined benefit pension from a different company and I now need to make a decision on the options available in taking this one. There are two main options I wish to consider:

1) Just take it as annual pension, or
2) Take a lump sum (say, 25%) and an appropriately reduced annual pension

I'm told by the pension provider that either of the above options will take up circa 10% of my lifetime allowance.

So I will then be 106% (96% + 10 %) of my personal lifetime allowance, so incurring a tax penalty charge when I come to draw this second pension.

The additional income from either option above will keep me in the 20% income tax band.

Which of the two options above will minimise my tax liability?

Thanks in anticipation.

ben_power
Posts:69
Joined:Tue Feb 27, 2018 8:34 pm

Re: Tax on Exceeding the Pension Lifetime Allowance

Postby ben_power » Fri Jan 07, 2022 11:30 pm

This isn't straightforward but I'll try to explain:

Lifetime Allowance (LTA) is currently fixed at £1,073,100 unless you have protection (individual/fixed) which sound unlikely from your post.

If you've already used 96% of your Lifetime Allowance (LTA) you have crystallised £1,030,176 leaving £42,924 reaming. This is important as it means that you will only be able to draw 25% of this tax free regardless of the value of the pension benefit.

Any benefits taken above the LTA will be taxed. If taken as 'income' you'll pay 25% LTA tax charge + your marginal rate if income tax. As a basic rate tax payer this would represent 45% in total. The alternative would be to take benefits as a lump sum (if offered) but this would attract an LTA tax charge of 55%. In your situation, it is likely that 'income' with a small element of tax free cash £10,731 (25% of the available LTA remaining) may be sensible. It is likely that the pension provider will tell you what the maximum tax free cash you can get is and therefore the rest would be taken as income and the LTA tax charge applied.

You 'may' also have the option of transferring the defined benefit pension out, giving up the valuable 'safeguarded benefits'. Whilst this would not be sensible in the vast majority of cases it should be considered, if only to dismiss. An example of when this could be sensible would be if you did not have a 'need' for the additional income. If you have sufficient income already then the 'benefit' (income) really isn't a great option for you. Transferring into a personal pension arrangement (SIPP) could offer you greater death benefits, I say you, ultimately this would be for your beneficiaries and you/the pot would still be liable to the LTA... simply put, there's no avoiding it!

russ101
Posts:4
Joined:Tue Apr 19, 2011 6:24 pm

Re: Tax on Exceeding the Pension Lifetime Allowance

Postby russ101 » Sat Jan 08, 2022 5:26 pm

Thank you for your comprehensive response - it is quite helpful

As you anticipated, I have no protection.

I don't have any beneficiaries, so I don't think the final options you mention will make sense in my case.

I hadn't contemplated that I should be able to take a smaller than 25% lump sum that would not attract a tax charge if that sum remained within the LTA limit. So that might be the option I go for and, as you say, the provider should tell me what that maximum amount should be.

A couple of follow questions if I may for clarification:

If I take it as income - so attracting a 25% tax - I assume the tax due is applied just on that proportion of the total benefit over the limit?

And secondly - the amount of tax due is a fixed amount isn't it? Is it not just 25% of the pension value above the limit? So why would I pay 45% tax (20% income tax plus the 25% LTA tax charge) every month I receive my pension income? The total LTA tax I would pay would then depend how long I lived rather than the fixed amount I would be liable for. I hope I have asked a sensible question there - I can't quite get my head around that bit.

Regards

ben_power
Posts:69
Joined:Tue Feb 27, 2018 8:34 pm

Re: Tax on Exceeding the Pension Lifetime Allowance

Postby ben_power » Mon Jan 10, 2022 12:12 am

In reality, if this is a defined benefit pension, the scheme administrator will ask you for information regarding any previous pension benefits claimed. This will allow them to assess the LTA usage and determine if a LTA charge needs to be applied. In your case, it sounds likely that the benefits taken (as income and/or tax free cash) will push you over the LTA. The scheme administrator will therefore apply the tax charge to the pension income but only on the part that exceeded the LTA, you won't really notice it as they'll be paying you net of tax but it will be in the background and always apply, even of your pension continues to increase each year with inflation.

You are correct though, if you live to 110 the chances are you'll have paid more tax.... but you'll have received the income for a lot longer too. If you're able to take the benefits above the LTA as a lump sum, you'll pay the 55% tax leaving you with a smaller pot but this can be utilised now (or invested to grow over the longer term). It's really a question of what's more useful to you, income or lump sum, there's no right answer, your circumstances will dictate but whatever decision you make HMRC will get their pound of flesh. It's a good problem to have.

russ101
Posts:4
Joined:Tue Apr 19, 2011 6:24 pm

Re: Tax on Exceeding the Pension Lifetime Allowance

Postby russ101 » Mon Jan 10, 2022 10:07 pm

Thank you for your further response - I agree it's a first world problem! But a "problem" nevertheless.

I sort of get it now that in terms of the longer you live, the more benefit you get - and so the Government get it's "share" also by taxing at that 25% flat rate every month just like the 20% income tax.

Yes, it's a defined benefit scheme so at "least" it will be taken at source by the Administrator so there won't be a continual reminder the Government are taking their bit every month.

By the way, the Administrator is Mercer who have so far (and seems will continue to be so) decidedly hopeless in the helping me explore the tax implications of the options open to me - hence why I have posted my question on this Forum.

From what I have read generally in the press, Mercer are pretty awful and I would have to agree with that conclusion.

So thank you for your help.

Regards


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