With the recent freezing of the pension lifetime allowance at the current level of £1,073,100, many clients are now looking at ways to mitigate this as nobody wants to get caught in the 55% tax trap.
The pension lifetime allowance is an incredibly complex piece of legislation, however, planned correctly, you don’t necessarily need to give 55% of your nest egg to the chancellor.
The lifetime allowance is taxable at two rates, 25% or 55%. If a lifetime allowance excess should occur, you can either opt to pay 55% tax and withdraw the excess as a one-off lump sum. The alternative is to pay a reduced rate of 25% and leave the balance to be used as income in the future. The final choice would be down to you.
However, there is a third option: opt not to pay a lifetime allowance tax at all by planning ahead.
The number one thing to understand when planning for the pension lifetime allowance is how your pension’s ‘classification’ is essential.
When you are still paying into a pension and have not taken any tax-free cash and not entered the pension into drawdown, the pension will be classified as ‘uncrystallised. When the pension has this classification, any investment growth that exceeds the lifetime allowance is treated as a lifetime allowance excess and will be taxed at either 25% or 55% in the future.
Your pension is worth £1,3000,000 and is ‘uncrystallised. You have exceeded the pension lifetime allowance by £226,900. Therefore, the lifetime allowance charge could be 25% of the excess, as long as the excess is left inside the pension and used for income in the future. In this case, the charge would be £56,725, plus income tax at your highest marginal rate when you withdraw the income in the future.
However, if your pension is classified as ‘crystallised’, the investment growth in excess of the lifetime allowance is treated entirely differently. Let’s use the same example. Your pension fund is worth £1,300,000, and the fund is crystallised. There would be no lifetime allowance tax to pay, and the excess could be withdrawn as income in the future and just your highest marginal rate of tax paid.
This simple status change would save £56,725 in this case and result in zero lifetime allowance tax becoming due.
So how do you change the status of your pension?
There are several ways to do this, such as taking the tax-free cash, having your pension tested against the lifetime allowance, entering the fund into drawdown. Deciding which is the best option for you will depend on your broader circumstances. You should always consult a qualified financial planner who has experience in the pension lifetime allowance.
If you have a pension lifetime allowance challenge and would like to consider the options available to you, I can offer you a complimentary 30- minute call to discuss your case and determine if there are any savings to be made.
If you’re wondering if we can help, book a free online consultation and find out. We don’t require a fact find or any long winded details, just a simple informal chat.