Interest charge

Neil MacGillivray: Taking the Hit – The Lifetime Allowance Charge, Part 2

A few months ago I wrote an article about possible outcomes for individuals with defined contribution arrangements that exceeded their lifetime allowance (LTA), and whether between the two options it was better to crystallize all of their benefits and take charge LTA’ strike now or crystallize up to their LTA and leave balance uncrystallized.

In this article, I had deliberately considered only the situation of an individual dying before the age of 75.

Following the release, I had a chat with an adviser who had run the numbers, just like me.

They had, however, taken the next step and considered the results for people reaching the age of 75. It is this aspect that I would now like to address.

Lifetime allowance after age 75

At age 75, there are two potential benefit crystallization events (BCEs) for defined contribution agreements, a BCE 5A, which tests all growth on a drawdown fund, and a BCE 5B, which tests all uncrystallized entitlements. Anything above the individual’s LTA is subject to a 25% tax charge.

The difficulty in performing these types of analyzes is to accurately account for the many variables.

For example, the return on investment, the rate of inflation, especially considering the current situation and the future income needs of the individual.

Any material deviation from the assumed rates, especially the latter two, could have a material impact on the eventual outcome with respect to any 75-year LTA charge. One thing we are almost certain of is that the Standard Lifetime Allowance (SLA) will remain at £1.0731 million until the end of the 2025/26 tax year.

Crystallizing Benefits

As in the previous article, the initial starting point was on the crystallization of benefits, a 60-year-old “individual” takes the maximum lump sum pension start (PCLS) and designates the balance to be drawn.

The starting income is 4% of the initial levy fund (75% of their LTA), but in my last calculation of numbers, increased by different inflation rates in iterations. They hold three years of cash income as a hedge against any market declines and no interest earned on the money.

Investment returns, net of fees, were set at both a constant rate and a floating rate, in the case of the latter they also averaged around 3%, 4%, 5% and 6% of yield. I performed 27 iterations, including when an individual held Fixed Protection 2016 (FP16).

As before, for all iterations before age 75, the value at death was the same regardless of the option chosen. It was not until age 75, where LTA testing is done, that there were differences in the value of funds available to beneficiaries.

For reference, I have included just six of these iterations in two tables below. Each chart is derived from different investment returns and inflation rates. They show net funds after any LTA charges due to a BCE 5A or 5B.

Return on investment 5%

Inflation 2%

Partial crystallization Complete crystallization
£1.25m fund with SLA £1,029,709 £1,006,656
£1.5m fund with SLA £1,419,222 £1,345,667
£1.5m fund with FP16 £1,267,913 £1,232,185

Return on investment 6%

Inflation 5%

Partial crystallization Complete crystallization
£1.25m fund with SLA £936,938 £936,938
£1.5m fund with SLA £1,386,350 £1,321,013
£1.5m fund with FP16 £1,170,377 £1,159,033

At age 75, residual funds were generally greater when only the amount up to the individual’s LTA was crystallized, particularly in cases where average investment returns were greater than the initial level of income drawn, e.g., 5 % return on investment with an initial income level of 4%. .

However, higher inflation rates narrowed the gap, for the simple reason that higher levels of income were needed over time to maintain purchasing power, which in turn dampened overall returns. investments and reduces the LTA load.

Impact of options after age 75

From my investigations, it seems that it makes no difference whichever option is chosen if a person were to die before the age of 75, as the beneficiary will receive the same amount in both cases. However, if the individual is expected to live past 75, I would say that on a balance of probabilities, crystallizing only to their LTA may produce a higher residual value.

I should perhaps just add the caveat that who knows what detrimental action a Chancellor might take with regard to pension tax legislation in the future, because we have certainly highlighted negative results with their tinkering of legislation in the past.

Neil MacGillivray is Technical Support Manager at James Hay, part of Nucleus.