There is a commonly held perception that continued pension funding above the LTA is always ‘bad’. We aim to outline why this may not always be the case, but also stress that advice is taken before any contributions are made.
It may be true that funding above the LTA for those who hold either Enhanced or Fixed Protection against previous LTA reductions is bad. This would result in forfeiting that benefit. In this scenario extra care and attention should be paid to the advantages and disadvantages before re-starting any funding.
But for everyone else rapidly approaching the Ă‚ÂŁ1 million or those just over, should you necessarily stop contributing? Pensions may still be the best place for savings. We feel that that such action should only be taken if there is not a better financial alternative.
Below are five common misunderstandings relating to the LTA:
Contributions Don’t Have to Stop Just Because the LTA has Been Reached.
Remember, the LTA is an ”˜allowance’, not a ‘limit’. There is nothing to stop clients carrying on funding into pensions beyond the LTA. Each individual can continue funding in line with their Annual Allowance and get tax relief at their highest marginal rates.
The LTA is not a barrier, it is simply the point where checks should be carried out to look at what the likely tax treatment of this additional fund will ultimately mean for clients based on their personal circumstances. In this way it is no different to any other taxable allowance (Income or Capital Gains Tax for example). Any breach will trigger a tax charge to be applied.
For all those clients who receive employer contributions into their pension, should these stop, there may be no alternative form of remuneration on offer. Where an employer does offer an alternative, this will be subject to income tax and NI. This can considerably strengthen the argument to carry on funding.
There is a Tax Charge to Pay as Soon as the LTA is Reached?
This is not strictly true. When a client hits the LTA a penalty will only apply should a crystallisation event occur. It may just mean that in the short term, the total value of their pension savings are in excess of what the LTA protects.
Typical crystallisation events are, when the fund is designated for drawdown or annuity purchase, a client reaches age 75, or death.
The LTA Tax Charge is Applied When You Start to Take Benefits?
Each time a client crystallises some of their pension a percentage of the LTA is used, but the charge itself only comes into play when there’s no longer enough LTA available to cover the amount being crystallised.
One way of manging this effectively is for clients to only crystallise the funds needed year on year, this is also known as phasing. Clients can then manage the timing of any potential LTA charge.
The only point at which phasing won’t work is on a clients’ 75th birthday, at which point uncrystallised funds will be tested along with any investment growth on already crystallised funds.
The Penalty for Exceeding the LTA is 55%?
The LTA charge is often expressed as 55%, but that is only payable if the whole of the chargeable amount is taken as a lump sum.
If the individual moves it to their drawdown pot, then the charge reduces to 25%. However, it is important to note that the 25% would be on top of the clients marginal rate of income tax which would be payable on any income taken from their pension pot. So depending on their tax status in retirement either method may prove more beneficial than the other.
On Death, There will be Another LTA Test on Funds in Drawdown?
There is no second LTA test on death for crystallised funds. If a client dies before age 75 their beneficiaries will be able to inherit the pot and take income and or lump sums tax free.
If a client dies after age 75, then the beneficiaries would pay income tax at their own marginal rates on any amounts drawn.
Summary
Taking the above points into account, we have established that it would probably make sense for clients to continue paying into their pensions above the LTA when:
Ӣ They are a member of a workplace pension for example. If a contribution is coming from the employer then the cost to the employee is nil. No cost to the individual and a taxed benefit is better than no benefit at all.
Ӣ Can your client can get higher tax relief on contributions paid in than will be deducted when benefits are paid out? If this outweighs the charge coming out or is charge neutral for being over the LTA then it has still been worth it.
Pension income aside, it is also important to stress the other benefits that funds held within a pension receive:
Ӣ Funds do not suffer further tax on income or gains.
Ӣ On death, they can be passed on free of Inheritance Tax (IHT) to provide lump sums or pension income for any named beneficiaries.
Ӣ For clients who do not rely on their pension savings in retirement, they can leave the funds invested for growth in the pension wrapper meaning they would be protected from IHT at 40%. Funds held within a pension wrapper do not form part of your estate provided that a nomination of beneficiaries for has been completed stating your wishes.
Ultimately, having a fund approaching the LTA does not mean that contributing into a pension has to cease. By seeking professional advice it might be that there are still reasons for clients to continue funding depending on their individual circumstances.
The above is intended as information only and should not be acted upon without first seeking the advice of your financial adviser.
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