Martin Jones: "With uncrystallised funds, the amount tested at age 75 is simply the value of those funds as at the client's 75th birthday."
Martin Jones urges advisers to remember the LTA test at age 75 and runs through some planning points in his latest article for PA
"However, remember the lifetime allowance test at age 75…"
That must be one of the caveats I write the most.
For clients with defined contribution pension schemes, their 75th birthday is the final point at which their pension benefits will be tested against the lifetime allowance (LTA). But given it's a broadly passive process, and not instigated by the client in any way, it's easy to overlook.
Here's a recap on how the test works and a summary of a few planning points to consider.
How are funds tested?
With uncrystallised funds, the amount tested at age 75 is simply the value of those funds as at the client's 75th birthday.
In terms of pensions in payment, lifetime annuities and defined benefit scheme pensions are not tested or revisited in any way. Similarly, income drawdown funds that came into payment before 6 April 2006 are not tested, albeit in some cases they can reduce the amount of LTA available.
For drawdown funds that came into payment on or after 6 April 2006, however, there is a further test at age 75.
Here, you take the amount of growth in the drawdown fund between the initial designation and the client's 75th birthday. This value is then run through the standard LTA calculation.
If the LTA usage takes the client over their available LTA, they will pay a tax charge of 25% of the excess, which will be deducted from the pension scheme.
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Example Emily initially took benefits from her personal pension in 2013 when her pension was valued at £1,000,000. She took £250,000 as a tax-free lump sum and designated £750,000 into drawdown. £250,000 x 100 / £1,500,000 = 16.66% £750,000 x 100 / £1,500,000 = 50.00% She turns 75 in 2022, at which point the drawdown fund is valued at £850,000. The growth of £100,000 is tested against the LTA. £100,000 x 100 / £1,073,100 = 9.31% Total LTA used = 75.97% |
Planning points
While there are no ways to ‘dodge' the LTA, there are a couple of points to consider for clients with high fund values.
If a client has uncrystallised funds and will be over the LTA at age 75, they could consider taking benefits from their pension before they turn 75. This would give them the option of taking any LTA excess as a lump sum, which you don't have at 75.
The lump sum would be subject to a tax charge of 55%, which is obviously higher than 25%, but this might still work out better overall if any subsequent income payments would have been taxed at more than 40% (and as long as it's not then left within their estate and later subject to IHT).
If a client has funds in drawdown and there is likely to be a tax charge at 75, the client might consider taking income payments before age 75. If they withdraw some of the growth in the drawdown fund, less gets tested at age 75 and there is a lower tax charge.
This could work out better if the client is a basic rate taxpayer (i.e., 20% income tax versus 25% LTA charge), especially if they still have any of their tax-free personal allowance available.
On a practical level, it's often a good idea to check whether the scheme administrator needs any LTA information in advance of the test or even whether, unless told otherwise, it will assume no LTA available and deduct a charge.
And if the client has more than one scheme, it's worth knowing that they can choose which scheme does the test first. This might be beneficial if it's preferable for a tax charge to come out of one scheme rather than another.
Martin Jones is technical manager at AJ Bell
