They could decide to crystallise all their pension funds before 75. Alternatively, they could only crystallise funds up to 100 per cent of their lifetime allowance and designate these to drawdown, leaving the remainder – the excess - uncrystallised.
If they choose this second route, they will then have to decide how to manage the second drawdown BCE at age 75. Should they take out an income which will allow them to always maintain the same drawdown fund value as the day they crystallised, and so avoid a lifetime allowance charge?
Or, in either case, should they just enjoy full investment growth, and resign themselves to paying a lifetime allowance charge at age 75? After all, they get to benefit from higher funds and paying a government charge may not be the worse outcome.
There is no right or wrong answer. It depends upon the specific circumstances of, and beliefs of, the client. There are, however, several key points to consider when pension planning to avoid or reduce a lifetime allowance charge.
- How likely is the member to live to age 75? Reaching age 75 is a key date in pension planning terms – a second drawdown BCE arises and income tax is due on beneficiary’s benefits. Most people celebrate their 75th birthday – only a third of the half a million people who die in England each year are younger than 75. But if they do expect to die early, they may want to crystallise immediately as there will not be a further BCE on death, and their beneficiaries can enjoy the full value of any investment growth on the fund between crystallisation and death.
- Tax rate on withdrawals – how much tax would someone pay if they took benefits out of the pension plan, possibly to avoid a lifetime allowance charge?
- Gifting money – if the member took money out of the pension plan would it sit within their estate or are they able to gift the money to others, bearing in mind the current inheritance tax (IHT) rules and allowances?
- Potential beneficiaries – if the member has no need for the pension fund money then they may want to leave it within the pension plan for the next generation. In that case who are the nominated beneficiaries and what rate of income tax will they pay? Do they need the money now or can they wait until the member dies until they receive the benefits?
- Other sources of income – what other investment or earned income is the member receiving? And how does this affect the level of tax they pay and the income they may need – or not need – from the pension plan?
Case study – Emily
Emily is 60. She is stopping work and has built up a Sipp fund of £1,273,100. She has no lifetime allowance protection. She also has other sources of income. But she wants to access her pension to realise the pension commencement lump sum (PCLS) to gift to her children to help them buy a house.
Emily decides to designate up to her lifetime allowance - £1,073,100 – into drawdown and take the maximum PCLS of £268,275. The remaining drawdown fund is £804,825. Her lifetime allowance is now fully used up. However, she still has £200,000 uncrystallised.
Should she leave this fund uncrystallised, or designate it to drawdown now and draw down an income to reduce any lifetime allowance charges at age 75?
Option 1 – fully crystallise
Emily decides to fully crystallise her whole pension fund.
She pays a lifetime allowance charge of £50,000 on her excess funds of £200,000, leaving her a drawdown fund of £954,825 (£804,825 + £150,000).
If at age 75 she wants to have the same drawdown fund as she does now (at age 60) – and so avoid a lifetime allowance charge at the second drawdown crystallisation event – she will need to withdraw income. If she made a withdrawal of £38,193 a year, she could avoid a future lifetime allowance charge (assuming 4 per cent a year net growth over 15 years).
At age 75 her drawdown fund is still worth £954,825. Plus she has withdrawn 15 years’ worth of £38,193, which is £572,895. Adding that to her drawdown fund gives a total of £1,527,720.
Option 2 – leave the excess uncrystallised
An alternative strategy is to leave her excess of £200,000 uncrystallised, and not to take any income from the pension fund.
At age 75, and assuming a growth rate of 4 per cent net of charges, her drawdown fund is £1,449,000 and her uncrystallised fund is £360,000. Emily will have to face two BCEs and pay two lots of lifetime allowance charges.