Pension lifetime allowance

[Amboseli]

What happens if when you die you're over your pension lifetime allowance?

I've just realised that I'm likely to be over the current allowance by the time I am likely to pop my clogs at say age 80 something based on life expectancy stats.

Age 53. At the moment £400k in pension. Likely to grow to £750k by 2032 at age 32 with continuing contributions until retirement.

After taking out tax free lump sum in 2032 leaving £550k approx we won't need to draw on the pension which will keep growing and likely to be above £1m by say 2052.

We're planning on using tax free lump sum to pay off mortgage but now wondering if I should reduce pension contributions. But then there probably won't be enough to pay off the mortgage later.

It's so confusing and complicated. Does anyone have any thoughts? Is there something I've missed?

Age 62 in 2032 not 32! I wish!

The lifetime allowance is on contributions not end value. Isn't it?

The lifetime allowance is on end value - one of the things that makes it unfair as you are punished for investing 'well'.

Does this help?
Guide to lifetime allowance

Not an expert but as I understand it there is no issue if you die at 80 having exceeded the lifetime allowance: the pension fund goes to your nominated beneficiaries free of inheritance tax.

However there are tax charges before that at 75 and when you take any money out. Link gives info.

All this is based on current rules and it is a virtual certainty there will be changes in the next 20 years which will change the above. It's quite possible there will be changes in the Budget next month: there has been quite a bit of noise around this and the generosity of tax reliefs being weighted towards the best off.

@HappyHolidai thanks for that, it does help. I could try and apply for the protection up to £1.25 which seems very complicated.

The only other option seems to be drawing out from the pension to keep it below the lifetime allowance which seems silly if we don't need the money and will pay income tax on it.

Have no idea what to do now. I could pay into an ISA instead of the pension but that will be post higher rate tax deduction and then use that to pay off the mortgage.

I used an investment return calculator and £550,000 growing at 5% over 20 years is likely to be worth £1.3m.

And the rules are always changing so it's very difficult to plan what to do.

It's a nice problem to have but the entire pot will be passed to DCs and I'd like to do what I can to pass as much on as possible.

I have heard of couples getting divorced and splitting the pension 50/50 meaning you both have your lifetime allowance. £225000 growing for 20 years would be £550k so within the current lifetime allowance. Seems a bit extreme though!

Again not an expert, but I believe a married couple has a lifetime allowance each, so you can fill them both up without going to the trouble of getting divorced!

@HappyHolidai yes but the one has £400000 in it and the other only £36000. So if we got divorced (!) and split the pensions equally there would be £218k in each pension allowing for £800k growth.

It's quite a good workaround but extreme and probably has lots of other implications we haven't even considered. I had just happened to read about it somewhere and it seems in theory like it could work!

I'm no expert but I think you are misunderstanding what a lifetime allowance is. As I understand it you can't pay more than the allowance into the scheme. If you are 62 in 2032 why on earth would it keep going up until 2052? You would stop paying in at retirement. Also I have no idea why you wouldn't draw down from it ever? Spousal benefits are a tiny percentage of the pensioners payments, if you both died together the whole lot would be gone and you'd have paid all that money in for it to disappear?

@whatyoulookingfor I could well have misunderstood the rules tbh.

It would keep going up as apart from taking out lump sum we wouldn't need to withdraw any more from it. So it will stay invested and keep growing. We wouldn't add to it again after withdrawing the lump sum.

We have rental income we'll be able to live on after paying off the mortgage which is why we won't need to draw on the pension. And also state pension on top at age 67.

If we both died together the pots would pass intact to the children. It's a DC pension, not DB. The one advantage of DC is that you don't lose it all when you die.

@whatyoulookingfor has actually misunderstood that bit.
You can keep going paying into a pension above the lifetime limit if you want.
But the tax disincentive means that there would have to be other very good reasons to do so.

Just keep drawing down enough to stay under the limit. You could always put £20k a year into an ISA.

PS If you die with a pension over the lifetime allowance, whoever inherits the pension will have to pay the excess charge.

Maybe think about making lifetime gifts out of income? This is a good guide www.investorschronicle.co.uk/managing-your-money/2022/07/21/what-does-hmrc-mean-by-gifts-from-surplus-income/

@LetMeSleepPleasex2 thank you, that is a good option. My parents are giving their excess income to me and my siblings. But their investments are in ISAs so no tax to pay.

Will have to seek financial advice. I find it hard to trust anyone though, you never know whether you're getting genuine advice or just whatever makes them the most money.

I think I didn't word it well, I meant you can't pay in more without paying tax. I still don't understand why you would keep money in your pension until you die. Seems pointless to me.

@whatyoulookingfor - at least one reason is tax. Pass on your ISA and there's 40% IHT on estates over £325k; pass on your pension and there's no IHT. And if you die before 75 the recipient doesn't pay any income tax on the pension either. Absurdly generous!

@whatyoulookingfor but what's the point of taking money out of the pension if you don't need it? With the rental income and state pension we'll have more than enough to live on. If we take money out of the pension we'll pay tax on money we don't even need. Doesn't make financial sense. Other than to keep below the lifetime allowance.

The pension pot can be passed on iht free to the DCs. The issue is the 55% tax payable if the amount exceeds the lifetime allowance which I hadn't considered until recently.

When you take money out of the pension there is usually a "crystallisation event" and this is tested against your (remaining) Lifetime Allowance. There is a final test against Lifetime Allowance at age 75, when a check is made of how much uncrystallised pension fund you have left plus how much growth there has been on any remaining crystallised fund.
Potentially you might incur the excess LTA tax charge at this point, if not before.

Don't invest the fund in assets that generate returns of 5% pa
Leave in a deposit fund when you hit retirement.
Problem solved

Why invest in a pension if you don't need to? Where is your retirement income going to come from if not from the pension fund?

Would it be worth your parents passing g their excess income directly to grant dchildren rather than children (yourselves) if the children don't need it?
Maybe pension contributions for the children.

@Sunseed this is getting more and more complicated. I think we definitely need to get some advice. This thing about testing seems a bit arbitrary as there could be a crash the day after it's tested!

@Marmight the pension money is invested in equities by the pension provider. The return is usually more than 5%, that's a fairly conservative figure. Why would I leave the money in a cash deposit account to be eroded by inflation for over 20 years?

It seems silly to not invest in a pension and forgoe the higher rate tax relief and employer contribution. I hadn't anticipated how much the money could grow after taking out 25% and then just leaving it.

The retirement income will come from rental income and state pension.

@Chasingsquirrels yes that's what we're doing, investing for the children as much as possible.

I think we're now going to put less into pensions and start paying more into ISAs.

@Amboseli
Nothing unusual in having a more cautious approach in your investments as you get older.
I'd be very surprised in your pot generated 5% growth every single year. Investment growth has never been linear.
Just don't complain that your investment returns are too 'high' and you (or your estate) might have to pay tax on the gain when also saying that you are using pensions to save tax.
You are in a very fortunate position and i wonder if seeing a solicitor (STEP Member) might assist with estate planning?

@Amboseli

Yes, you definitely need proper, personalised advice from an IFA. They will be able to consider your specific needs and objectives (including Estate Planning) in the context of your own particular circumstances. You're at exactly the right age to be planning ahead and be able to make adjustments where necessary.

If you don't already have an IFA in mind you could ask about for local recommendations, or look up the Personal Finance Society's directory of regulated advisers and search my town/postcode. Speak to a few to find one that you're comfortable with.

From what you are writing the lifetime protection is not available to you because your pot was not already at a high enough level in 2016.
you would think lifetime allowance would go up with inflation, it certainly was in the party manifesto on which this government was elected. They have now frozen it until 2025 and so think they will reduce it further.
We are also expecting them to reduce the amount you can take tax free.
From 15 March I expect my phones will ring non-stop with clients wanting to take out cash before everything changes on 6 April.

LTA is likely to go up in that period though, it's frozen for now but unlikely to be for the long term.

If I'm reading this right, you're putting money into a pension you have no intention of using in retirement? It's purely for your children's inheritance?

In which case, can't you do something different with the money now? Buy property etc in their name? Or just gift them them the money / pay for grandchildren in nursery / whatever is appropriate.

As an adult child in a COL crisis they may appreciate less now rather than the promise of more in the future when they themselves are possibly getting old and passed the time when money is most needed. Adults age 20-40 can make more life changing use of inheritance more than those age 40-60 do (generally speaking)