Turning 75 has always been a significant point for anyone with pension savings. Even though compulsory purchase of an annuity by the age of 75 was abolished in April 2011, the 75th birthday remains an important pension milestone. After age 75 members are no longer eligible for tax relief, death benefits become taxable and for most it will be the last event where there is a test against the lifetime allowance.
It’s the mechanics of the lifetime allowance test that I’m going to focus on in this article, particularly with regard to defined contribution pensions. I’ll also mention a couple of planning points to bear in mind for clients approaching 75.
For any uncrystallised funds it is simply the value of those funds at age 75 that is tested against the LTA at that point.
Pensions in payment through a lifetime annuity or a defined benefits scheme pension are not tested or revisited at age 75, however for drawdown funds that came into payment on or after 6 April 2006 a further test on the growth of these funds since initial designation takes place on this date.
Case study 1
Suzanne has just turned 75. She has a SIPP with an uncrystallised arrangement, and a post A-Day flexi-access drawdown arrangement.
The fund split on her 75th birthday is as follows:
- Uncrystallised arrangement: £227,184
- Flexi-access drawdown arrangement: £700,000
And the previous BCEs have occurred:
- 2008/09 – PCLS £100,000 / drawdown £300,000 (24.24% LTA used)
- 2012/13 – PCLS £120,000 / drawdown £360,000 (32.00% LTA used)
Age 75 test
Uncrystallised funds BCE5b – here, we are simply testing the full value of the uncrystallised funds.
- £227,184 ÷ £1,073,100 x 100 = 21.17%
Drawdown funds BCE5a – as the funds have already been tested against the LTA when the BCEs originally happened, in essence we are testing the fund growth since it was initially designated into drawdown.
- £700,000 – (£300,000 + £360,000) = £40,000 ÷ £1,073,100 x 100 = 3.72%
Total LTA used at age 75: 21.17% + 3.72% = 24.89%
Total LTA used by all BCEs: 24.24% + 32.00% + 24.89% = 81.13%
Suzanne’s total LTA usage is within the LTA cap. Assuming she does not have any other pension schemes elsewhere, she will not have to pay an LTA tax charge.
Tax charge at age 75
If at age 75 the total usage exceeds 100% of the member’s LTA a tax charge will apply. The LTA charge that applies at the point of this BCE test is always 25% on the excess above the LTA. There is no option to take the excess as a lump sum and pay a 55% tax charge as you could if you exceeded the LTA taking a PCLS and drawdown before this age. In nearly all cases the provider will deduct the tax charge from the pension, pass this to HMRC and adjust the benefits accordingly.
Cast Study 2
Luke reaches age 75 on 6 May 2022. He has an uncrystallised fund valued at £1,500,000. He has no transitional or scheme specific protection and has had no previous BCEs, meaning he has not used up any of his lifetime allowance yet.
Age 75 test
Uncrystallised funds BCE5b: £1,500,000 ÷ £1,073,100 x 100 = 139.78%
In total at age 75 Luke has used 139.78% of his LTA
- 139.78% - 100% = 39.78% (the percentage excess)
- 39.78% x £1,073,100 = £426,879.18 (the monetary excess)
- £426,879.18 x 25% = £106,719.80
Luke therefore incurs a tax charge of £106,719.80 that the scheme administrator will deduct from the funds and pay to HMRC.
One further point to consider for Luke is his remaining pension commencement lump sum (PCLS) entitlement, as the different rules slightly overlap here. PCLS entitlement is defined in relation to a person’s remaining LTA. Specifically, PCLS entitlement is a quarter of their remaining LTA.
Before the age of 75 the member will be using up both their LTA and PCLS entitlement and will run out of both at the same time. But at age 75, they may have used up their LTA entitlement without taking a PCLS. If you carried on defining their PCLS entitlement as a quarter of their remaining LTA, they would lose PCLS entitlement at age 75.
When taking benefits after age 75, the rules have to work differently to make sure the PCLS entitlement is maintained. Although taking benefits after turning 75 is not an official BCE, you still have to work out a ‘deemed’ amount of remaining LTA to work out the PCLS entitlement.
When calculating the remaining PCLS entitlement after the test at 75, the member is deemed to be entitled to the amount of PCLS they could have withdrawn immediately before this test took place.
The maximum PCLS from uncrystallised funds is still calculated as 25% of available LTA. However, it ignores any LTA used at age 75.
So, for Luke, he would still have his full PCLS entitlement of £268,275 after the age of 75 (25% of £1,073,100) even though he has no available LTA.
Before 2006, the lifetime allowance didn’t exist. However, pension benefits in the form of lifetime annuities and final salary scheme pensions had existed for decades: even income drawdown has been around since 1995.
Therefore, there were hundreds of thousands of pension scheme members who had taken benefits from their pensions but who had never had their benefits assessed against the new lifetime allowance.
From a technical perspective, pre-A-Day benefits are largely ignored for LTA purposes. However, those members who started taking benefits don’t get away with it. At the member’s first BCE after A-Day, a one-off calculation takes place to account for any pre-A-Day benefits.
This is referred to as a ‘deemed reduction’ of available LTA. It is not a BCE or an LTA test, because it cannot result in a tax charge itself. However, it still reduces the LTA available going into any other BCEs.
This is important to be aware of because the LTA test at age 75 could be that first post A-Day BCE. For example, it’s not uncommon to have a client with a DB scheme that they accessed at age 65 and a SIPP they had been building up on the side but hadn’t touched.
The method for calculating the value of pre-A-Day funds is slightly different: the current monetary value is not used as this is not particularly indicative of the benefits the member has actually received, given they could have been taking income for a number of years.
Because of this, the rules provide us with a different methodology. This involves taking the maximum income from the pre-A-Day benefits and multiplying it by a factor of 25. This produces a monetary value that we can use for the purpose of this one-off LTA assessment.
The full calculations look like this:
- Max income x 25 = Monetary value
- (Monetary value) / (Standard LTA) x 100 = Deemed reduction
Although note that for income drawdown the first part of the calculation looks like this.
- (Max income x 25) x 80% = Monetary value
Case study 3
Charlotte has a SIPP from which she first took benefits in 2005. She took a PCLS of £110,000 and designated £330,000 into drawdown.
She has just turned 75. Her fund split as at her 75th birthday is as follows:
- Uncrystallised arrangement: £278,000
- Capped drawdown arrangement: £350,000
The maximum income from her capped drawdown arrangement is £37,080.
The capped arrangement was in place before A-Day so is not tested. However, as this is the first BCE since A-Day the deemed reduction calculation takes place:
Deemed LTA reduction
- £37,080 x 25 x 80% = £741,600
- £741,600 ÷ £1,073,100 x 100 = 69.10% LTA reduction
- 100.00% - 69.10% = 30.90% LTA remaining
This means Charlotte has 30.90% LTA available for the age 75 LTA test on her SIPP.
Uncrystallised funds BCE5b:
- £278,000 ÷ £1,073,100 x 100 = 25.90%
In total, Charlotte has used 95% of her LTA. She will not incur a tax charge.
The final test
Age 75 will be the final LTA test for most; the only BCE that can be triggered after an individual’s 75th birthday is where a scheme pension in payment is increased beyond the permitted margin.
Any defined benefits already in payment before age 75 do not face a second LTA test at this date. There is a separate test, BCE3, if there is a significant increase in benefits outside of the normal annual increases, but no automatic test on reaching age 75.
There is no getting around the LTA test at age 75, however forward planning could potentially mitigate the charge.
Clients with funds in drawdown before their 75th birthday could reduce their fund value simply by taking income payments. These payments would be subject to Income Tax but depending on the client’s overall tax position there could be a saving versus the 25% LTA charge at age 75. For example, a basic rate taxpayer with personal allowance available would make a saving paying income tax at 20% on anything over the personal allowance compared to the 25% charge on the LTA excess. This would of course draw the funds into the client’s estate, losing the Inheritance Tax benefits of the pension.
Where LTA tests occur on the same day, the rules allow for the member to choose the order in which they are applied. So, for a member with multiple schemes at age 75 they can effectively choose which scheme pays any LTA charge.
This flexibility can be useful, particularly if a client holds both DB and DC schemes, as the DC scheme can be selected to pay the charge, therefore not reducing the potentially more valuable DB benefits.
The allowance had been increasing in line with the Consumer Prices Index (CPI) from 2018-19, with increases to £1,030,000 for 2018-19 and £1,055,000 for 2019-20 and then £1,073,100 for 2020-21.
The Chancellor announced in March 2021 that the allowance would remain at £1,073,100 until April 2026. This freeze will likely see more exceed their LTA and is unfortunate timing for those approaching age 75 in the next few years.
This article was previously published by FT Adviser
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