In a nutshell, I will move money from SIPP/DC to Drawdown a.s.a.p. to minimise my use of the LTA. I might exceed the LTA, so if we have spare money to put in a pension, we will put it in my wife’s SIPP, not mine.
I believe that the lifetime allowance is in place to limit the amount that is worth saving through a pension, so that the associated tax breaks are given to low-mid earners, and it’s capped for high earners. If a 40% taxpayers later exceeds the limit it’s probably not a disaster but you might have chosen to do something else with the contributions if you’d known. If a 20% taxpayer contributes to a pension and later exceeds the limit, it’s not good at all.
There are a number of events that count towards using up your lifetime allowance. The main ones for me are going to be:
- Moving money from SIPP/DC to Drawdown/Current accounts. The 25% tax free is only free of income tax – it still counts for the lifetime allowance. As does the remaining 75%.
- 20 times the annual sum at the start of a DB pension.
- Tax free sum from a DB scheme.
- When I get to age 75, if I haven’t yet emptied my SIPP/DC then what’s left is counted, and the lifetime allowance maths is thus completed. (My plan is to empty the SIPP/DC long before age 75.)
- When I get to 75, the value of EACH drawdown account is compared to the inputs and if it’s higher then the extra is counted. Weirdly, simply withdrawing money from every drawdown account can ensure this is avoided.
When you invest you usually hope to get growth above inflation – perhaps you are planning based on RPI plus 3%.
The Lifetime allowance can move based on political whim, but at present it is planned to increase with inflation.
That means your SIPP/DC is growing faster than the allowance. If it grows 3% faster, then in the 20 years from age 55 to 75 that’s an 81% increase relative to the allowance.
So it’s almost certainly best to get it counted early against the lifetime allowance and then let it grow in a drawdown or ISA account.
Paying extra into a SIPP or AVC will add to your usage of the lifetime allowance when it moves back out. That might be no problem, or it might be.
Here’s the detail:
These two tables show the effect of exceeding the LTA.
If you have student loan 9% or child benefit taper to include, you should change some percentages when you create the first of these tables for yourself.
First, what if you have gross pay and you are deciding whether take it as income now to put in an ISA, or to put it in a DC pension as an extra one-off contribution. Consider your tax rate now and in retirement.
The second table is to decide whether to make a payment into a SIPP if you have the money in your current account. First work out how much will appear in your SIPP, and then use the orange or blue part of the table as appropriate.
Overall, you can see that if you exceed the LTA, it’s not great. But if you avoid putting money in a pension because of LTA-fear and then get nowhere near the LTA, you have missed out.
Paying CGT versus exceeding the LTA
I’m getting increasingly nervous about exceeding the LTA with its huge tax hit. Instead, when I get to 55 I will move the vast majority of my SIPPs (or maybe 100% of them) into drawdown and get the 25% tax free, but then that tax free sum will not fit immediately into my ISAs. That means they will be invested and subject to CGT, and then moved into ISAs as fast as I can manage. But the CGT allowance and CGT rate means less tax than if I exceed the LTA allowance.
Bridging Pensions and LTA
It seems I may get a bridging pension from one of my ex employers’ DB pension schemes. Bridging pensions are also known as Temporary Pensions or Step-Down Pensions. They came into being when DB schemes’ default retirement age became a few years below state retirement age, so retirees found they couldn’t make ends meet for a few years. The retirees pension was boosted for those years and then reverted to the usual pension.
I think I am going to have to be VERY careful to stay on the right side of the Lifetime Allowance without incurring various unwelcome taxes. My bridging pension isn’t a lot but could be the straw that breaks the camel’s back. Bizarrely, bridging pensions eat up 20x their annual value of my LTA, even though they only last for a few years and so are worth far less than the main pension (which is also rated at 20x). (There might be some refinement or correction of that to come – I spoke to the Pensions Advisory Service and they say that if the bridging pension is my first pension then it’s definitely 20x, but in my case it will be my last pension to start so I’m not sure what difference that may make – we’ll see.)
At least I get to choose the sequence of BCE events when they are simultaneous. So when this DB pension starts, the 25% tax free will be counted first, and then I can choose whether the next BCE is the main pension or the bridging pension. Of course I will choose to BCE the temporary one last, so any LTA hit is temporary.