lumin news Issue 6 / Autumn 2022
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Page 4 <strong>lumin</strong> <strong>news</strong> 6 / autumn <strong>2022</strong><br />
Learn how the pension lifetime allowance<br />
tax test works<br />
Many people leave their personal pensions untouched, but are unaware that there<br />
is an automatic tax test at the age of 75. Likewise, there is a secondary test at 75 if<br />
you have accessed your pension funds earlier.<br />
JAMES DELANEY<br />
Financial Consultant<br />
james.delaney@<strong>lumin</strong>wealth.co.uk<br />
Phone 02039 887 788<br />
The maximum value you<br />
can build up in your<br />
pension pot is currently<br />
£1,073,100. More people<br />
are expected to exceed this<br />
‘lifetime allowance’, as the<br />
threshold has been frozen<br />
until April 2026. You should<br />
weigh up your choices carefully<br />
if you have large pension<br />
savings – particularly if<br />
you are continuing to make<br />
contributions – and watch<br />
out for the mandatory test<br />
event at age 75.<br />
Test at time benefits<br />
are taken, or at age 75<br />
If you have left your pension<br />
plan(s) untouched,<br />
your unused pension funds<br />
will be tested against the<br />
lifetime allowance ceiling<br />
Watch out for an excess tax charge on your<br />
drawdown account<br />
Assumptions: Maximum cash lump sum (25%) of pension plan worth<br />
£1,000,000 taken in 2017/18 at age 67; remainder (£750,000) designated<br />
to drawdown; 4% investment growth p.a. (net of fees); figures rounded.<br />
Market value of<br />
pension at age 75<br />
Pension value<br />
when designated<br />
to drawdown at 67<br />
at the time you take benefits<br />
before age 75, or when<br />
you reach 75. The lifetime<br />
allowance should adjust in<br />
line with inflation again<br />
from the 2026/27 tax year.<br />
Secondary test<br />
at age 75<br />
Some pension plan holders<br />
choose to take their tax-free<br />
cash lump sum (normally<br />
25%, or up to £268,275<br />
if the plan value is at or<br />
above the current lifetime<br />
allowance threshold of<br />
Scenario 1:<br />
No income<br />
taken<br />
Scenario 2:<br />
£30,000 income<br />
per year<br />
£1,020,000 £750,000<br />
£750,000 £750,000<br />
Difference £270,000 –<br />
25% lifetime allowance<br />
excess tax charge<br />
How does the secondary test at age 75 work?<br />
Pension<br />
plan<br />
market<br />
value<br />
Lifetime<br />
allowance<br />
tax test<br />
Drawdown<br />
funds (75%)<br />
2 nd lifetime<br />
allowance test<br />
at age 75<br />
Tax-free<br />
cash (25%)<br />
£67,500 £0<br />
£1,073,100) and assign the<br />
remainder to a drawdown<br />
account, which allows you<br />
to take flexible income<br />
as and when you need it.<br />
However, it is not common<br />
knowledge that these drawdown<br />
funds face a second<br />
test at age 75.<br />
Case study<br />
In the example above, a<br />
67-year-old had a pension<br />
worth £1,000,000 in<br />
2017/18. At that time, the<br />
lifetime allowance was also<br />
£1,000,000, so 100% of<br />
the allowance was used up.<br />
If no income is taken from<br />
the plan, and the drawdown<br />
funds benefit from investment<br />
growth, the market<br />
value of the plan will be<br />
higher at age 75 compared<br />
to when the funds were designated<br />
to drawdown. As<br />
the example illustrates, this<br />
would result in a significant<br />
tax charge at age 75 (25%<br />
of £270,000).<br />
This is a simplified example.<br />
We often encounter<br />
clients with more than one<br />
private pension, with different<br />
pots accessed at different<br />
times. Independent<br />
experts can help to provide<br />
a clear picture and strategy.<br />
Tax treatment<br />
Consider broader tax consequences<br />
when assessing<br />
your pension options. Pensions,<br />
including drawdown<br />
funds, feature outside of the<br />
estate for inheritance tax<br />
(IHT) purposes. Although<br />
the 25% cash lump sum can<br />
be taken without an immediate<br />
tax charge applying, it<br />
forms part of your estate for<br />
IHT purposes, and also becomes<br />
liable for income and<br />
capital gains taxes.<br />
Do you need pension<br />
planning to help you<br />
make well-informed financial<br />
decisions? The lifetime<br />
allowance is a complicated<br />
area of tax planning, but an<br />
expert can help you understand<br />
your options and assess<br />
whether you can take<br />
action to mitigate tax liabilities.<br />
Call 03300 564 446 to<br />
learn more.<br />
FACTSHEET/WEBINAR<br />
Overcoming lifetime<br />
allowance<br />
challenges<br />
Request a free factsheet or<br />
join our webinar (see page<br />
12). Email info@<strong>lumin</strong>wealth.co.uk,<br />
or call the<br />
team on 03300 564 446