Life Time Allowance - Now or Later?

[JohnnyCyclops]

I've not considered LTA before, imagining it was a horizon I'd never meet. I've now looked into LTA at the £1m level but am confused whether that's today's valuation or the forecast value at some future date when I retire and start to access the pensions I've built up.

Aged 48, I'm currently in an employer's DC scheme and expect to continue working until at least 60. I've got an earlier employer's DC scheme (dormant); a small SIPP containing some transferred DC funds (no new funds being added); two DB pensions (both dormant) - one in the Local Govt Pension Scheme, and another from a private employer that's now inside the Pension Protection Fund. The two DCs are in a mix of trackers - mostly equities, some fixed income.

So do I tot up the current values and compare to £1m? Or look to a future date, and then what date to use? The two DB schemes have normal retirement ages of 65. The SIPP I could start to access age 55. The DC schemes probably could be accessed from 55, or I may keep paying in while I'm working, if that goes beyond 55. Given the pension income (or initial lump sums) could be accessed at different times, when is the trigger for the LTA?

If I take current valuations and apply a 3% annual growth rate, and assume I'll keep paying into the current employer's DC scheme, is that sufficient. And how should I tackle inflation assumptions?

I've always assumed paying into the company scheme is a good thing, that I'll be a higher rate tax payer in employment but basic rate in retirement, so pensions made sense. I want to make sure, with ~12 year employment left in me, that's still a valid decision.

[JohnB]

Its assessed each time you change the way you get money out (or reach 75). As you split your pot up to get lump sums, and start income streams with drawdown, to crystallize it in the jargon, you use up fractions of the LTA on each tranche.

The LTA is indexed linked to CPI, and will rise to £1030000 in April. If that continues (and I'm not sure I trust the Tories to stop that, and I'm sure Labour will), you could just assume that the DB pensions will rise at CPI, and just consider if the DC ones will out-perform inflation. I'm 49, and think I'll squeeze under the limits, but who knows over the next 7 years

[Chrysalis]

Yes, each time you take benefits (eg start to take a DB pension, or take sums out of your DC pensions), what you take will be valued against the current LTA and will ‘use up’ a proportion of it. Defined benefit pensions are valued at 20x the annual pension, plus any lump sum. DC pensions are valued as the amount of funds you crystallise.
I am sure there must be some govnt info on this, try looking at money advice service or the pensions advisory service websites - not checked it out myself.
It is complicated, there are nuances (small pots less than 10k can be taken without affecting LTA for example). There is also an argument that the LTA charge isn’t particularly punitive, depending really on how much it costs you to contribute to your pension, and therefore it may still be worth adding to your pension even if you are getting close to LTA (who knows when the next market crash might be anyway). For example, if you are getting employer contributions then that’s still free money even if it gets taxed on the way out. It’s just less free money.

[ursaminortaur]

Yes, each time you take benefits (eg start to take a DB pension, or take sums out of your DC pensions), what you take will be valued against the current LTA and will ‘use up’ a proportion of it. Defined benefit pensions are valued at 20x the annual pension, plus any lump sum. DC pensions are valued as the amount of funds you crystallise.
I am sure there must be some govnt info on this, try looking at money advice service or the pensions advisory service websites - not checked it out myself.
It is complicated, there are nuances (small pots less than 10k can be taken without affecting LTA for example). There is also an argument that the LTA charge isn’t particularly punitive, depending really on how much it costs you to contribute to your pension, and therefore it may still be worth adding to your pension even if you are getting close to LTA (who knows when the next market crash might be anyway). For example, if you are getting employer contributions then that’s still free money even if it gets taxed on the way out. It’s just less free money.

A list of the BCEs ( Benefit Crystallisation Events) which cause a test to be carried out against the LTA limit is available from
https://www.aegon.co.uk/support/faq/pension-technical/Benefit-crystallisation-event3.html

[Alaric]

Yes, each time you take benefits (eg start to take a DB pension, or take sums out of your DC pensions), what you take will be valued against the current LTA and will ‘use up’ a proportion of it.

It's tested at the time you take benefits, but if you exceed the LTA at an earlier date, you are likely to exceed it at a later date as well. As others have noted, the LTA is supposed to be revalued with CPI inflation. That doesn't help so much as you might hope as the value of your pension would increase as well. Bear in mind that the value for Defined Benefit schemes at 20x annual income is arbitrary and likely to be less than the true "worth" of the pension promise once it comes closer to being in payment.

[JohnnyCyclops]

The answer appears to be "later", rather than me reaching a point now of £1m, I need to forecast ahead to either 55, or a 'target date' when I'll start to draw a pension or receive a first lump sum. This seems rather tricky. While I usually err on the side of caution for investment growth (typically 3% p.a.) in this case I might want to pick a racier growth rate (say 5% or even higher) and project forwards. I'd always assume the LTA was a 'current' measure of amounts invested.

And, as may be obvious, what's true today as to LTA values, may not be true in 5, 10 or 15 years' time based on government whim and dictat.

[JohnnyCyclops]

There is also an argument that the LTA charge isn’t particularly punitive, depending really on how much it costs you to contribute to your pension, and therefore it may still be worth adding to your pension even if you are getting close to LTA (who knows when the next market crash might be anyway). For example, if you are getting employer contributions then that’s still free money even if it gets taxed on the way out. It’s just less free money.

Yes, true, and I'd likely still keep that portion going which also requires me to make a contribution. However, I'm also voluntarily making extra regular contributions in the belief of the tax benefit, but I'll have to revisit that decision. I might instead choose to receive extra taxed pay now and then invest via an ISA. I only favoured the pension route because of my assumption that I'll be a basic-rate taxpayer in retirement but a higher rate payer currently in employment. The LTA tax impact muddies it and requires more thought.

What is the tax impact of going above the LTA? I'd read 55% tax rate (compared to basis tax rate of 25%). That does seem steep. Or maybe I'm misunderstanding tax (and not for the first time!).

[DrBunsenHoneydew]

What is the tax impact of going above the LTA? I'd read 55% tax rate (compared to basis tax rate of 25%). That does seem steep. Or maybe I'm misunderstanding tax (and not for the first time!).

If you exceed the LTA, the tax rate imposed depends on how you draw out the excess funds. Take them as a lump sum and you lose 55%. Take it as income payments, you lose 25% of each payment and then the remaining 75% is taxed as income. So a £100k LTA exceedance will leave you £45k as a lump sum, or if taken as £4k annually you lose £1k plus either 20% of the other 3k, leaving £2400 for a basic rate taxpayer, or lose £1k and 40% of 3k leaving £1800 for a 40% taxpayer.

[ursaminortaur]

What is the tax impact of going above the LTA? I'd read 55% tax rate (compared to basis tax rate of 25%). That does seem steep. Or maybe I'm misunderstanding tax (and not for the first time!).

If you exceed the LTA, the tax rate imposed depends on how you draw out the excess funds. Take them as a lump sum and you lose 55%. Take it as income payments, you lose 25% of each payment and then the remaining 75% is taxed as income. So a £100k LTA exceedance will leave you £45k as a lump sum, or if taken as £4k annually you lose £1k plus either 20% of the other 3k, leaving £2400 for a basic rate taxpayer, or lose £1k and 40% of 3k leaving £1800 for a 40% taxpayer.

If you draw out the excess as income then it is reduced by 25% because of the excess charge and then you pay your normal marginal tax rate. If your marginal tax rate is 40% then this works out as a 55% reduction ie the same as if you took it out as a lump sum. If though your marginal tax rate is less then you are better off taking the excess as income rather than as a lump sum. Alternatively if your marginal tax rate is 45% then you would be better off taking the excess as a lump sum.

(1 - 25/100) x (1 - 40/100) = (1 - 55/100)

[JohnnyCyclops]

What is the tax impact of going above the LTA? I'd read 55% tax rate (compared to basis tax rate of 25%). That does seem steep. Or maybe I'm misunderstanding tax (and not for the first time!).

If you exceed the LTA, the tax rate imposed depends on how you draw out the excess funds. Take them as a lump sum and you lose 55%. Take it as income payments, you lose 25% of each payment and then the remaining 75% is taxed as income. So a £100k LTA exceedance will leave you £45k as a lump sum, or if taken as £4k annually you lose £1k plus either 20% of the other 3k, leaving £2400 for a basic rate taxpayer, or lose £1k and 40% of 3k leaving £1800 for a 40% taxpayer.

If you draw out the excess as income then it is reduced by 25% because of the excess charge and then you pay your normal marginal tax rate. If your marginal tax rate is 40% then this works out as a 55% reduction ie the same as if you took it out as a lump sum. If though your marginal tax rate is less then you are better off taking the excess as income rather than as a lump sum. Alternatively if your marginal tax rate is 45% then you would be better off taking the excess as a lump sum.

(1 - 25/100) x (1 - 40/100) = (1 - 55/100)

Thanks both. This is completely changing my view of pensions! I need to do some careful sums and for the first time in a long long while feel the need for an IFA to help me think through (or calculate through) the options. I sense I'm on the boundary (or whole be by the time I'm 65) for LTA to apply. I can also see myself in paid/salaried employment beyond 55 and don't want to give up my employer's pensions contribution, which is an important part of my overall package.

Loving the name also, Dr Bunsen!

[parallellines]

I sense I'm on the boundary (or whole be by the time I'm 65) for LTA to apply. I can also see myself in paid/salaried employment beyond 55 and don't want to give up my employer's pensions contribution, which is an important part of my overall package.

Ask your employer if they will pay cash in lieu of the pension contributions ...taxed, but better than losing them althogether. Many do.

[JohnnyCyclops]

I sense I'm on the boundary (or whole be by the time I'm 65) for LTA to apply. I can also see myself in paid/salaried employment beyond 55 and don't want to give up my employer's pensions contribution, which is an important part of my overall package.

Ask your employer if they will pay cash in lieu of the pension contributions ...taxed, but better than losing them althogether. Many do.

Good point. I have a friend who's just joined the same firm, and it was he who mentioned he's at the LTA and will need to stop the automatic enrollment. He's quite shrewd so I'm sure he won't be forgoing the company's contribution. I'll check with him, or with HR directly.