Ahead of the Lifetime Allowance reduction on 6 April 2016, you have limited planning time to avoid a tax charge, but beware of Group and Family SIPPs as you'll see below
The Lifetime Allowance Reduction Could Affect Many Middle Income Families
Lifetime Allowance – Talk About Moving The Goalposts!
Although you can grow your fund value in registered pension schemes as large as you like, there’s an overall limit to the maximum fund value of your tax privileged benefits known as the Lifetime Allowance. If your fund value exceeds the limit, tax is due.
Your Lifetime Allowance is calculated as the total value of all your pension plans, typically UK-registered pension schemes. These include your money purchase pensions like SIPPs and other personal pensions together with your company pensions such as your final salary schemes.
When Lifetime Allowance was first introduced on 6 April 2006, it was set at £1.5 million. It rose to £1.8 million, but on 6 April 2012, it was reduced back to £1.5 million. Two years later it was cut to £1.25 million and on 6 April 2016, it will be slashed to just £1 million.
It’s expected to raise around £600 million for the Treasury. If you don't pay attention to this change, you might find your SIPP inadvertently contributes to this tax take.
The Lifetime Allowance Charge
Drawing An Income
If you take the excess as a pension, you’ll suffer a Lifetime Allowance charge of 25 per cent and that’s in addition to any Income Tax you’ll pay on your withdrawals at your marginal rate of tax.
Taking A Lump Sum
If you take the excess as a lump sum, you’ll suffer a Lifetime Allowance charge of 55 per cent.
Why Lifetime Allowance Doesn’t Just Affect The Rich
To blame is our friend, compound interest. Whilst it works wonderfully over longer periods to grow your pension fund effectively, it’s arguably a double-edged sword. For if your pension fund grows too quickly, you’ll be affected by a nasty Lifetime Allowance tax charge.
By way of example, take someone starting a career on an annual income of £30,000. If they enjoy average pay rises of 5 per cent per year, they contribute the recommended 15 per cent of salary to a SIPP which grows at 7 per cent per year net of charges, they’d breach the new Lifetime Allowance limit after 32 years.
That’s well ahead of their State Pension age, and by no means would you describe them as wealthy!
How To Check If You’re Near The Lifetime Allowance
You should take into account the value of all your personal and company pensions. It’s a bit technical, but here goes:
- The current value of money purchase pension funds that have not been used to provide any pension benefits.
- 20 times the annual pension due from any final salary pensions not in payment, plus any additional tax-free cash.
- The percentage of the lifetime allowance used up by pension benefits taken since 5 April 2006, as stated by your pension provider. This percentage does not change when the lifetime allowance changes.
- 25 times any annual pension in payment before 6 April 2006. If you have taken pension benefits after 5 April 2006, use the value as at the date you first took benefits after 5 April 2006; for drawdown this is 25 times the maximum income. If you have a drawdown pension set up before April 2006 and have not taken any further benefits, you should use 20 times maximum income if:
You are in capped drawdown.
You converted to flexible drawdown after 5 April 2015. This is the maximum that would have applied when you converted.
You converted to flexible drawdown before 6 April 2015 in a pension year that started after 26 March 2014. This is the maximum that would have applied when you converted.
Protecting Your Lifetime Allowance
When the lifetime allowance was introduced, you could apply for protection against a potential lifetime allowance charge. If you have successfully applied, you’ll have received a certificate from HMRC.
Over the years, various protections have been available, including enhanced protection, primary protection and fixed protection. It was even possible to protect your tax free cash. Details of the protection for the forthcoming 2016 reduction will be released in due course.
The best idea is not to wait. It’ll pay you to do your sums now, so that when the protection rules are published, you’ll be able to act in good time if it applies to you.
For information on the Lifetime Allowance, visit the Money Advice Service for some helpful guidance. If you need specific advice, talk to your trusted independent financial adviser, or speak to our recommended IFA.
Beware Of Group And Family SIPPs
Some SIPP operators may allow you to arrange your SIPP in conjunction with family members or with work colleagues. There's a belief that investment growth on one person's pension can be allocated to another person whose SIPP is linked. For example, if a husband's SIPP is worth £600,000 and his wife's is worth £200,000, he might be able to avoid breaching the Lifetime Allowance limit by allocating his SIPP growth to her SIPP.
In consultation with a well respected regulatory SIPP lawyer, you would be wise to steer well clear of these arrangements. The opinion suggests that reallocating funds between members could be an unauthorised payment assuming the members are connected, which they would be in the example above. The penalty from HMRC is a 55 per tax charge, and the SIPP operator could be fined a scheme sanction charge of 40 per cent, which it would almost certainly pass on to you.
If you're part of a group or family SIPP, you should be aware you could lose most of your pension fund if HMRC chooses to investigate, though it's worth pointing out this is just one legal opinion, all be it a reputable one. As we're all aware, HMRC is on the warpath to recover tax wherever possible, so be warned this could be a real issue for you at some point in the future.
If you think the constant changes to Lifetime Allowance are rather confusing, you’re not alone. Weirdly, the day that Lifetime Allowance was introduced was supposed to usher in the new world of ‘pension simplification’.
I reckon someone was having a laugh!
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Over time, charges can wipe out a huge part of your fund. We like AJ Bell because there are no set-up costs. If you hold passive funds, which is our preference, or shares, investment trusts, EFTs, gilts or bonds, you pay one small fixed fee no matter how large your fund. And when you come to draw your benefits either as occasional drawdown or UFPLS payments, there's a small charge for the whole year no matter how many times you access your money (many SIPP and SSAS providers charge more than this for each payment).
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