As your retirement approaches, you’ll start to think about your available pension options and how you might withdraw your funds.
But there are other things to consider too, beyond the pension option you choose.
Understanding the Lifetime Allowance (LTA), knowing the Annual Allowance that applies to you, and considering the implications of not taking your pension at all, could all help you make the right choice for you.
1. What is the LTA, how are my funds tested against it, and how much is the charge?
The Lifetime Allowance (LTA) limits the amount of pension benefits you can withdraw without triggering an extra tax charge.
When it was introduced back in 2016, the LTA was £1.5 million. It rose to £1.8 million before dropping back to £1 million in 2016. From 2018 it has increased in line with the Consumer Prices Index (CPI) and will rise by 0.5% in April 2021, up to £1,078,900.
Your benefits will be tested against this amount when you access your pension in a way that triggers a Benefit Crystallisation Event (BCE). There are thirteen BCEs currently, and we can help you identify if your pension plans would result in a test being carried out.
Pension benefits over the LTA will be liable for a tax charge of 55% if you are taking the excess as a lump sum, and 25% if the excess is taken as income.
If your pension funds are close to the current LTA (and you have no HMRC protection in place) we can help you manage your withdrawals to mitigate the impact of an LTA charge.
2. What Annual Allowance applies to me?
The pension’s Annual Allowance is the amount you can contribute to a pension each year and still get tax relief. However, the Annual Allowance might not apply to you.
If you are a high earner or have already accessed some of your pension benefits flexibly, a new – and lower – allowance could apply.
- The pensions Annual Allowance
The pensions Annual Allowance for the 2020/21 tax year is £40,000. That means you can pay £40,000 (or up to 100% of your earnings if lower) into your pension during the tax year and still get tax relief.
It’s important to track the amounts going into your pensions each year, not least because any unused Annual Allowance can be carried forward for up to three years.
- The Money Purchase Annual Allowance (MPAA)
You’ll trigger the MPAA if you ‘flexibly’ access any taxable Defined Contribution (DC) pension funds you hold. This usually means using one of the new Pension Freedom options available from 2015. Triggering the MPAA reduces your allowance to just £4,000.
The MPAA will trigger if you take your whole pension pot as an Uncrystallised Fund Pension Lump Sum (UFPLS), for example, or you start making ad-hoc lump sum withdrawals from your pension pot.
Receiving income from funds in a Flexi-Access Drawdown scheme will also trigger the MPAA (although designating the funds without drawing down income from them will not).
Accessing tax-free cash only will not trigger the MPAA, nor will:
- Taking a Pension Commencement Lump Sum (PCLS) and buying a level annuity or one that increases
- Taking tax-free cash and designating funds to Flexi-Access Drawdown without taking any income
- Cashing in small pension pots (defined as those below £10,000)
If you’re thinking of taking DC benefits but want to continue contributing to other pensions you hold, you’ll need to be aware of the MPAA. Speak to us and we can help you decide whether it’s right for you.
- The Tapered Annual Allowance
If you’re a high earner you might trigger the Tapered Annual Allowance. The taper reduces your allowance by £1 for every £2 your income exceeds a set amount.
For the 2020/21 tax year, you’ll need to check if your ‘threshold income’ is above £200,000. If so, you’ll need to calculate if your ‘adjusted income’ is more than £240,000.
Threshold income is all of your taxable income, such as your salary, bonuses, and pension. Your adjusted income is the same, except that it also includes employer pension contributions.
If your threshold income is above £200,000 and your adjusted income is more than £240,000, your Annual Allowance will reduce by £1 for every £2 that your ‘adjusted income’ exceeds the limit, down to the minimum tapered allowance of £4,000.
These calculations can be tricky, so speak to us if you’re unsure.
3. Should I take my pension, or should I pass it on to the next generation?
Your pension might not be your only source of retirement income. If you have investments or income from elsewhere, you might opt not to take your pension at all.
Leaving your pension (or one of your pensions) invested gives it the chance to make future gains – although of course there is the risk it makes a loss too.
You might also be able to pass your uncrystallised funds on to your children.
If you die before the age of 75, any unused pension pot remains outside of your estate for Inheritance Tax (IHT) calculation purposes. You can pass 100% of it on to your chosen beneficiary, tax-free.
Your beneficiary will pay tax at their marginal rate if you die after the age of 75.
This is a tax-efficient way to pass money to the next generation but only if you can afford it. Speak to us if you’re considering leaving your pension pot untouched and we can help you decide if it’s the right option for you.
Also, note that a beneficiary is added to a pension by your provider, rather than through your will.
Get in touch
If you’d like to discuss any aspect of your retirement or estate planning, get in touch. Please email info@investmentsense.co.uk or call 0115 933 8433.
Please note
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The value of your investment (and any income from them) can go down as well as up which would have an impact on the level of pension benefits available.
Your pension income could also be affected by the interest rates at the time you take your benefits. The tax implications of pension withdrawals will be based on your individual circumstances. Levels, bases of and reliefs from taxation may change in subsequent Finance Acts.
