The age 75 dilemma – what matters?

17 August 2021

With the LTA frozen, for those using drawdown, when reaching age 75 is it better to take income to try to avoid the tax charge, or to leave it invested?  Lisa Webster, senior technical analyst at AJ Bell looks at the options

With the freezing of the lifetime allowance (LTA) for the next five years more and more people are going to find themselves subject to the LTA charge – as we all know, a monetary freeze is in real terms a cut. A-day legislation stating the LTA was only going to go up seems like a distant memory.

This cut, coupled with the decline in annuities being purchased, means that the number of people receiving a LTA charge as a rather unwelcome 75th birthday present will be on the up.

Drawdown is increasingly popular, and it is important to remember that post A-Day drawdown funds are tested twice in the member’s lifetime if they live to age 75. This brings about a dilemma for those with LTA issues. Is it better to remove the growth from the pension by taking it as income, so there is no further tax charge at 75, or to leave it invested?

If you crunch the numbers on this, the difference isn’t always that significant. If funds are left invested to benefit from compound tax-free growth over the years, there may be a hefty sounding LTA charge at 75, but that’s because the fund is far bigger than it would have been otherwise. Once the LTA charge has been deducted the overall wealth position may be no worse than if income had been taken out over the years.

What’s more likely to be relevant to the decision are other circumstances specific to your client.

The most obvious starting point is whether income is needed. If it is, clearly at least some of the growth is going to be deducted. But for those with other sources of income where extra is not needed then there may be little point in deducting funds to avoid a 25% LTA charge, particularly if the funds withdrawn then form part of their estate on death and end up subject to IHT at 40%. For some clients making regular gifts out of income could be an option. Provided their standard of living isn’t affected and appropriate records are kept, then such gifts should remain outside of their estate on death.

Taking this a step further, some clients may want to withdraw funds and use them to make regular pension contributions for an adult child. Provided the (adult) child of the member had sufficient earnings and annual allowance this could be a tax efficient way of moving funds away from the family member with an LTA issue to one who hasn’t. Even if the parent is a higher rate taxpayer and pays 40% tax when taking income from their pension, if the child is also a higher rate taxpayer and qualifies for relief then this is tax-neutral within the family. Just remember it will be the child who gets the higher rate relief not the parent.

Health is another factor to consider. For those unlikely to make it to 75 fully crystallising now could be the preferred option – the LTA is higher in real terms than it’s going to be in the next few years –then only withdrawing what is going to be immediately needed. Those who don’t make it to 75 don’t have crystallised funds tested again on death, so no need to worry about the growth.

Rates of income tax payable are relevant whether thinking about the member making withdrawals in their lifetime, or any tax payable by their beneficiaries. As an example someone who is already a higher rate taxpayer may prefer to leave funds invested and leave some of their pension to basic rate or even non-taxpayers to inherit, rather than pay 40% income tax now and make gifts out of income.

As with a lot of financial planning, the decision isn’t straightforward. There isn’t a one-size-fits-all approach that works. Getting to the heart of the client’s priorities will be key and avoiding a LTA charge may not be everything.

Professional Paraplanner