Defined benefit transfers and the lifetime allowance

Clare Moffat looks at the planning implications of DB transfers and the LTA

By Clare Moffat – Head of Business Development, Royal London

Many clients have been fortunate enough to see large defined benefit transfers recently. But these often come with a potential lifetime allowance (LTA) tax charge.

What does this mean for your client? Can they avoid paying the charge?

Let’s look at an example:

Meet Mark

  • Mark has worked for an engineering firm for the last 40 years.
  • He is about to retire at age 61 and is widowed with 2 adult children.
  • He also receives a dependant’s pension of £20,000.

If he remained in the scheme then his annual pension would be £42,000. Taking that pension a benefit crystallisation event and he would have used 20 x £42,000 = £840,000. So within the current LTA of £1,030,000.

However, Mark has taken advice and decided to transfer his pension. His transfer value is £1,470,000. This means that he’s exceeded the LTA by £440,000.

Protection from the LTA charge

There are still two forms of protection which can be applied for: individual protection 2016 and fixed protection 2016. Unfortunately for Mark neither is available to him. Although there’s no minimum for fixed protection he would have had to stop accruing benefits in the scheme from 6 April 2016 and opted out. But he didn’t.

For individual protection 2016, Mark would have needed to have benefits in excess of £1m on the 5 April 2016 which wasn’t the case until the transfer completed.  So Mark is in a similar position to many people who have transferred.  He’s subject to an LTA excess charge.

So what are his options?

Paying the charge

If Mark decides to move all of his retirement savings into drawdown then he’ll be able to take 25% tax-free cash, but this is limited to 25% of the standard LTA. So he would receive £257,500.

He could choose to take the excess of £440,000 as a lump sum or income. A lump sum is taxed at 55% so he’d receive £198,000 into his bank account with no further income tax charge. But that cash is now part of his estate for inheritance tax (IHT) purposes.

Or he could choose to take the excess £440,000 as income and a 25% LTA excess tax charge would be deducted. The remaining £330,000 would move into drawdown which is an IHT-friendly environment and can be passed on through the generations. The disadvantage is when he draws money out, income tax will be deducted by the scheme. Mark already has a taxable dependant’s scheme pension and depending on the size of his withdrawals could mean he’s a higher-rate taxpayer which would mean an effective rate of tax for the excess of 55%.

Delaying the charge

Mark doesn’t have to move into drawdown now. He could transfer into an accumulation pot and no tax charge would be payable yet.  If he does want to access some of his retirement savings then he could take up to the standard LTA without a tax charge.  He’ll still have to pay a tax charge if he crystallises any more savings or when he reaches 75. If he dies before 75 his beneficiaries will have to pay the tax charge.

The right answer?

With LTA charges there is no right answer. Some clients are happy to pay the tax charge upfront but if they take the excess as a lump sum then it’s important that it isn’t sitting in a bank account waiting for an IHT charge. Taking it as drawdown could be more tax-efficient. Not taking more than the LTA might be a very good idea especially if growth from drawdown is used or invested.

As with all planning, it’s important to do the sums as well as considering the client’s, and potentially their beneficiaries’, circumstances.

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