Pensions still revolve around two key milestones: age 55, when benefits can be accessed, and more importantly, in my opinion, age 75. This is because of the raft of choices and decisions consumers are forced to make at this point.
It has not really ever been clear why government persists with 75 as the precise age at which these choices happen, other than the need for an upper age limit. It may change in the future as we all live and work longer, but in the short term this looks unlikely.
For this reason it is important to address the issues facing consumers at this pivotal age of retirement planning.
Contributions
Contributions to pension schemes tend to stop at age 75, although this is only really relevant for personal contributions because individual tax relief ceases at this juncture. However, in theory, it is possible to pay gross personal contributions to a pension scheme, and as they are not eligible for tax relief they wouldn’t be tested against the annual allowance.
Employer contributions can continue after the age of 75 while retaining tax relievable status, so would face the annual allowance test. This is despite the fact they won’t ever be tested against the lifetime allowance (LTA).
There may well be scheme rules in place to stop any contributions after the age of 75 or higher, so if this is something that may be of interest to clients it is wise to check before any funds are sent to the scheme. These additional contributions won’t be tested against the LTA at any point and the employer should still receive corporation tax relief if they meet the “wholly and exclusively” test, just like any other contributions.
Default fund switches
Default fund switches have become less frequent since the advent of pension freedoms. Nevertheless, they still happen, and therefore scheme documentation should be checked thoroughly to ensure funds aren’t moved into cash or a money market fund in the run up to age 75, or a selected retirement date held on the provider’s systems. This could lead to a client’s funds being withdrawn from the market at an inopportune time, as well as the possibility of additional costs.
Schemes that do operate with a default switch may well only offer an annuity at retirement: the switching process exists to offer protection against last-minute fluctuations in the market. If an annuity isn’t going to be the correct product to provide the client with retirement income, then dealing with this issue sooner rather than later is key.
Access to transfers
Despite its increasing popularity, a significant amount of schemes still fail to offer drawdown. In this scenario, a client wanting drawdown would need to transfer to another scheme. However, even more schemes don’t operate beyond age 75, and as a result would insist the client buys an annuity at age 75 or transfers out beforehand. It is best not to leave funds in these schemes until the last minute, because if the transfer hits a snag and isn’t completed before the client’s 75th birthday, an annuity purchase may then be the only option. It may seem unfair, but this outcome is often dictated by scheme rules and the necessary systems may well not be in place to process the transfer after this date.
Pension commencement lump sums
One big change in recent years is the ability to defer pension commencement lump sums beyond age 75. To many, it would seem foolhardy to leave the cash within the scheme, because should the client die then the tax-free portion would become taxable. But think of it another way: should the client not need the pension commencement lump sum, then taking it out will just add to their estate for inheritance tax purposes, potentially being taxed at 40 per cent anyway. If left in the scheme, beneficiaries could make withdrawals at their marginal rate of income tax as and when required, while the sum continues to grow in a tax-free environment. What’s best for the client will clearly depend on their financial circumstances as a whole.
Clients can still access their pension commencement lump sum after the age of 75, subject to scheme rules. The calculation to establish exactly how much they can access ignores the benefit crystallisation events that occur at age 75, which clarify how much of the LTA they have remaining in order to determine the maximum cash that can be accessed. So, for example, if they have only used 50 per cent of the LTA before age 75 and have not drawn down any cash or crystallised funds since, they would be able to take up to 25 per cent of the current £1m LTA as a pension commencement lump sum.
Retest of drawdown funds
For those who have crystallised funds into drawdown previously, it should be remembered that a further LTA test on all post A-day drawdown funds occurs on their 75th birthday. This test looks at any growth in the fund after income has been taken out. For those that crystallise at age 55, this could be 20 years of growth, so could result in a LTA charge if not monitored.
The test is relatively simple and measures the current fund value versus what was originally taken through the benefit crystallisation event (that is, the amount put into drawdown, after PCLS). If the current figure is higher than the amount that went in originally, then there is a further benefit crystallisation event (BCE) amount and the client will need to have sufficient LTA available to avoid a 25 per cent charge on the excess.
This test is made more complex if some of the drawdown fund has been used to buy an annuity at any point since entering drawdown, as the annuity purchase figure will need to be removed.
Last lifetime allowance test
Age 75 sees the end of LTA tests both in life and on death, unless the client has a scheme pension that suddenly increases above a set amount – a relatively unlikely event. If this does take place, it won’t cause a BCE if the increase meets certain criteria.
This means growth in the fund after age 75 will not be tested against the LTA and should still remain outside of the client’s estate on death for IHT purposes. This is provided no transfers are made when in serious ill-health or within two years of their death.
Death benefits
One of the biggest changes that happens for beneficiaries at the age of 75 is that death benefits start becoming taxable income. This applies to both income and lump sums, but it probably has the biggest impact on money left to a trust.
It is always good practice to keep expression of wish forms up to date, but this becomes even more important for those reaching age 75. A nominated trust would be able to receive the funds from a pension scheme tax-free before 75, but will be taxed at a flat rate of 45 per cent if the member dies after 75. This means that within the trust only 55 per cent of the death benefit is invested, even though the beneficiary will be able to get a credit for the tax paid when they eventually receive a payment from the trust.
Death benefit options vary dramatically between schemes, so the choices available before and after age 75 may not be the same. Yet again, it is a case of checking the scheme rules to establish exactly what is on offer and if they still meet a client’s needs. Because of the issues with IHT for transfers when in ill health, these matters need to be addressed prior to the client becoming ill.
Final thoughts
The rules surrounding age 75 still seem very arbitrary and unjust in some cases. Many people will live far beyond age 75 and more and more will continue to work. Increasingly, we are seeing greater interest in employer contributions after the age of 75, and this is only going to increase.
Because of this, forcing consumers to make decisions at this age is making less and less sense, and should be addressed if we want pensions to still be attractive in the future.
Claire Trott is head of pensions strategy at Technical Connection
