I’m 70. I’ve touched very little of my pension funds. All the untouched funds are in a SIPP. I expect to be ‘tested’ against the lifetime allowance at 75. Unless there is another crash like 2008 or 2020, I will exceed the standard lifetime allowance. I’m not sure how the tax on my excess will work.

Suppose I’m £120,000 over the limit and I’m hit with a £30,000 lifetime allowance charge. I leave the remaining £90,000 in the SIPP. Does it go back into the general SIPP or does it become a separate fund? Do I still get the 25% tax free when I take out a lump sum?

Paul

Tom Selby, AJ Bell Senior Analyst says:

For the current tax year (2021/22) the lifetime allowance stands at £1,073,100 and it will remain at this level until 2025/26 after which it is due to be reviewed. Some people may be entitled to a higher figure than this if they have one of the various ‘protections’ that exist.

You can read more about these protections and the terms that come with them here.

The amount of lifetime allowance used will be tested whenever a ‘benefit crystallisation event’ occurs.

These events include:

– taking your 25% tax-free cash;

– putting your pension into drawdown;

– taking an ad-hoc lump sum;

– buying an annuity;

– death (if you die before age 75 and have funds in your pension not allocated to drawdown);

– your 75th

The age 75 test is often one that people focus on, in part because it captures any growth in your fund since entering drawdown as well as any untouched funds.

It is therefore possible that someone who hadn’t breached the lifetime allowance before age 75 subsequently breaches it at this point in time and is hit with a lifetime allowance charge.

The lifetime allowance is more of a ’check point’ than a hard limit that you have to stay under. Pension funds over the value of the lifetime allowance will be subject to a tax charge, and once you have used up your lifetime allowance, you will not be entitled to any tax-free cash on the excess.

So, for example, someone with a lifetime allowance of £1,073,100 and a fund of £1,200,000 could take a maximum of £268,275 in tax-free cash. It is still possible to take tax-free cash after age 75, up to this limit.

When a lifetime allowance test takes place before the age of 75 the level of the charge will be:

– 25% if you leave the excess in the pension (with income tax charged when you subsequently make a withdrawal);

– 55% if you take the excess out of your pension as a lump sum (with no more tax due).

If you reach age 75 with funds in your pension, the lifetime allowance charge on any excess will always be 25% with the remainder of the excess staying in your pension. Once the lifetime allowance charge has been taken you should have a single pension pot with your provider. For those who reach age 75, this will be the final time their pension is tested against the lifetime allowance.

DO YOU HAVE A QUESTION ON RETIREMENT ISSUES?

Send an email with the words ‘Retirement question’ in the subject line to asktom@sharesmagazine.co.uk. We’ll do our best to respond in a future edition of Shares.

Please note, we only provide guidance and we do not provide financial advice. If you’re unsure please consult a suitably qualified financial adviser. We cannot comment on individual investment portfolios.

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