Technical: Tax tests at age 75
23 October 2017
Pension freedoms didn’t remove the importance of age 75 but it did make it more complicated, particularly in respect of the Lifetime Allowance. Elaine Turtle, director, DP Pensions, looks at a recent case and how the client was saved £213,840 in tax charges.
When Chancellor George Osborne changed the pensions regime forever, by announcing the introduction of freedom and choice for all, there were some existing quirks to the pensions system that remained, especially in relation to those reaching age 75.
Where once reaching the age of 75 had been the catalyst to purchase an annuity, or to take benefits from a pension scheme, that requirement has long since disappeared.
Reaching the age of 75 triggers two specific areas for consideration by both an adviser and the client/pension scheme member. The first is the tax treatment of death benefits post age 75 and the second being a further test of pension savings against the individuals remaining lifetime allowance (LTA).
Case in point
We recently worked with an adviser on their client’s options. The client is 70 years old and approaching his Lifetime Allowance limit and he wanted to consider taking benefits before his LTA was breached. Mr Silver has a self invested personal pension (SIPP) worth £1.48 million and is fortunate enough to also have a final salary scheme that was in payment before 2006. He has Fixed Protection in place at £1.8 million.
His final salary pension scheme pays out £12,000 per annum, so when this is multiplied by 25, his fund for the lifetime allowance calculations is valued at £300,000. When this is added to the value of his SIPP it amounts to £1.78 million. His final salary scheme is deemed to have used 16.66% of his protected LTA.
As Mr Silver has not taken any of the tax free cash available to him, he still has the ability to take that now, and this would reduce any potential tax liability at age 75 when the LTA test is carried out again.
Mr Silver agrees with his adviser to crystallise his entire SIPP taking the maximum possible lump sum but no immediate income payment. He is able to take 25% of his SIPP, which for Mr Silver would be £370,000. The balance of the SIPP is worth £1,110,000.
The value of the SIPP amounts to 82.22% of Mr Silver’s protected Lifetime Allowance (1.48m/1.8m). The total lifetime allowance used is 82.22% plus 16.66% deemed to have been used from the final salary scheme. In total this is 98.88%.
Mr Silver has 1.12% of available lifetime allowance at age 75 before a tax charge becomes due. Any value in excess of the protected lifetime allowance would be subject to a tax charge dependent on whether the excess is taken as a lump sum (55%) or as income (25%)
As explained, a further LTA test will be required at age 75. This test measures any further growth (after tax free cash) on Mr Silver’s SIPP since he crystallised the benefits at age 70.
If we assume Mr Silver’s SIPP were to increase by 5% each year between now and age 75, his SIPP would be worth £1,416,672, the growth being £316,672 or a further 17.59% of Mr Silver’s protected LTA (316,672/1,800,000).
Mr Silver has now used 116.47% of his LTA and would be subject to a tax charge on the excess over and above the LTA. The excess amounts to £296,460 and so the tax charge (assuming the excess were taken as a lump sum) would be £163,053.
However, if Mr Silver is able to discuss with his adviser the benefits of taking the potential growth as income this would avoid a LTA tax charge. Any income would be taxed at Mr Silver’s marginal rate as opposed to 55%.
If Mr Silver had not taken his lump sum at age 70 and his SIPP were still to increase by 5% each year, his SIPP would be worth £1,888,896. Adding the value of his final salary scheme provides a total value of £2,188,896. This represents 121.60% of the lifetime allowance and so the tax charge (on the same basis as before) would be £213,840. Mr Silver has no opportunity to take either a lump sum or income to reduce the tax due.
Mr Silver is very fortunate to have had a relationship with his adviser for many years and they meet annually to discuss his investments and other financial issues. The adviser proactively discussed the tax implications of him reaching his 75th birthday and so there was time to look at his options and agree a way forward that would mitigate the tax charge and be advantageous to him.
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