I've consolidated two pensions into a SIPP and now find I could be looking at exceeding the lifetime allowance. What should I do?
20 July 2021
Question by John
I hope you can help. I recently consolidated two modest pensions into a SIPP in readiness to start UPFLS drawdown in May (2018). Whilst I was hoping for growth in my investments I wasn’t expecting it to rocket and now find I could well be looking at exceeding the lifetime allowance, possibly even before my first annual drawdown in May, and I’m unsure what, if anything, I should do. Unless you have another option it looks to me as if I have two alternatives : • Keep within the LTA, sell the shares and hold in cash when the SIPP reaches approx £930-950K (which could be imminent) – leaving a cushion of spare capacity for interest over the next 10/15 years. Are you allowed to hold your entire pension in cash and drawdown from it annually? • Let it grow unfettered, exceed the LTA and take the excess as a lump sum with 55% tax. Is this treated as a separate transaction and would I still be able to withdraw an annual payment from my LTA as a normal UPFLS, i.e. with 25% tax free and 75% at normal tax rates? In other words, can I view the excess as a ‘bonus’? As the excess lump sum withdrawal will slice the overall fund back to the lifetime limit and consequently any growth at all will automatically become excess, then presumably this situation will repeat for successive years. Is this permissible and advantageous or are there implications, tax or otherwise, that I’m missing. Or would your advice be to avoid exceeding the LTA as it’s more trouble than it’s worth? Having for once been fortunate enough to have bought into what appears to be stock with a solid future of growth (famous last words!) it would be criminal and heartbreaking if I have to sell them only to watch their steady rise. I would value your opinion, suggestions, advice and any correction of my understanding of the rules or flaws I've missed. Thanking you in advance for your time and consideration. Jt, London
Answered by Boring Money
It’s understandable that you want to minimise the impact of tax on your pension fund but in this case I would argue that paying a lifetime allowance* tax is a good thing. It means you have more money in your pension fund than you planned. If you hold it all in cash and get no growth above £1 million that’s all you’ll have. If the fund keeps growing you’ll still get to keep at least 45% of the excess over the million. Would you rather have 100% of nothing over £1 million or 45% of anything over £1 million?
To answer your first question, yes, you can hold your entire fund in cash but I struggle to think why this would ever be a good idea. Based on current interest rates, your fund would struggle to keep pace with inflation and that’s without you drawing anything.
If you let it grow and it exceeds the lifetime allowance, you have the option to take part or all of the excess as a lump sum and this would be taxed at 55%, normally paid by the pension fund. You also have the option to draw the excess as an income with 25% deducted from the fund and you would then pay income tax. If you’re a higher rate taxpayer this would be at 40%. The combined tax on income would be 55%. It’s tax neutral whichever way you go.
You can use the UFPLS withdrawal method on any fund up to your remaining lifetime allowance if you’re under 75. If over 75, as long as you have some remaining lifetime allowance you can use UFPLS but the 25% tax free cash is limited to 25% of your remaining lifetime allowance.
There is a long list of events that trigger the lifetime allowance test. In your case the most relevant will be when you take benefits from your pension and again at 75. The calculation at 75 is based on the ‘growth’ in your drawdown fund since you started taking benefits. It’s quite complex and takes into account previous withdrawals and so there is scope to plan for it. I’d refer back to my previous comment; if you have a lifetime allowance tax charge in the future it’s because you have a bigger pension fund. Yes, you'll be giving the tax man a chunk but you’ll still have more.
In short, no-one would ask for the lifetime allowance charge if we didn’t already have it. Invest your pension fund based on what’s best for you in retirement. Embrace the lifetime allowance charge as it means you have more money than you thought you would.
Hope this helps!
* From April 5th 2020, the Lifetime Allowance rises marginally to £1,073,100.