Nucleus: Rise in LTA may have big consequences and substantial tax savings

The lifetime allowance will likely increase in April 2018. Advisers need to now work with clients who are taking pension benefits over the next few months and for whom the lifetime allowance may be an issue. The timing of taking benefits may be crucial in managing these clients’ tax charges.
Background:

• The lifetime allowance was introduced in 2006. There is no limit on the total amount of benefits a member can take from their registered pension scheme. However, an individual has a single lifetime allowance, and if the accumulated value of the benefits they take is greater than this allowance, then the excess is subject to the lifetime allowance charge. Individuals, most commonly, use up their lifetime allowance when they start to take their pension benefits, but there are other occasions that trigger a test of pension savings against the lifetime allowance – these are called ‘benefit crystallisation events’ (BCEs).
• After rising steadily from £1.5m (in 2006) to £1.8m (in 2010), the lifetime allowance (LTA) has been subsequently reduced in stages to £1m over the last five years. However, from April next year it will start to rise again
• The Finance Act 2016 (paragraph 19 (2)) outlines the standard lifetime allowance for every tax year – starting from 2018/19 – will be increased by the rate in CPI (multiple of £100). The rate used will be in September rate.
• On one level this seems to go against the recent direction of travel. There has been endless discussion about pensions tax relief over the past few years – varying from wholesale reform (and moving to a pension Isa) to the incessant chipping away at the allowance levels (whether that is the lifetime allowance or the annual allowance). There are regular predictions amongst the industry that the lifetime allowance will go down from £1m.
• However, in July the Treasury confirmed its decision to press ahead with an increase in the LTA.
• The rates of CPI for July and August were both 2.6%. There is speculation that the rate of CPI is generally increasing.  If the rate was 2.6% the new LTA would be £1,026,000. The rate will be confirmed 12 September 2017.

Rachel Vahey, product technical manager, comments:
“After five years of chipping away at pensions tax allowances, the lifetime allowance will reverse direction and start to increase from April next year in line with inflation. Although it may only be a small percentage increase, the rise in the lifetime allowance may have big consequences for some clients and mean substantial tax savings.
Advisers will need to work with their clients who are thinking of taking benefits over the next few months, and for whom the lifetime allowance may be an issue. These clients may want to consider delaying taking benefits until next April, as they may be able to cut  – or even eliminate – the amount of tax they have to pay. Also, as the amount of any benefits taken when tested against the lifetime allowance is expressed as a percentage of LTA, if clients delay taking benefits until after April the amount used up will be a smaller percentage of LTA giving themselves additional ‘wriggle room’ and possibly reducing any lifetime allowance charge they have to pay.”
A couple of examples:
Example one
Tommy has benefits of £1,100,000. Unfortunately, he has no protection. If he took his benefits in September then he would have £100,000 excess over the LTA, and if he withdrew his excess fund as a lump sum, he would pay a tax of 55% – £55,000.
However, if he took his benefits in April 2018 and assuming the LTA has been increased to £1,026,000, then he would have an excess of £74,000, and pay tax of £40,700 (55%). This saves him £14,300 tax.
Example two
Sarah wants to crystallise her Sipp worth £800,000. She has already used up 21% of her LTA.
If she crystallises in March 2018 her LTA would be 80% (£800/£1m) plus 21% = 101% and a tax charge is due on the excess over the LTA.
If she crystallises in April, her LTA would be 78% (£800/£1.026m) plus 21% = 99%