‘I have a tricky lifetime allowance situation’
I have enjoyed a substantial defined benefit pension since retiring in 2002. My initial annual pension was £125,000 and it has seen 5% annual increases since then.
I also have an uncrystallised SIPP now valued at about £270,000. How will my lifetime allowance be calculated and will my SIPP have a 25% tax charge when I reach 75 this year?
Tom Selby AJ Bell Senior Analyst says:
Both defined benefit (DB) and defined contribution (DC) pensions (including SIPPs) are controlled by the same lifetime allowance. This currently stands at £1,055,000.
Each time you ‘crystallise’ a pension (essentially meaning convert it into a retirement income) you use up a portion of your lifetime allowance.
Your case is interesting because you started taking your DB pension before the lifetime allowance was created in April 2006. However, this doesn’t mean you’ll escape a tax charge – instead your DB pension will reduce your available lifetime allowance based on its value on your 75th birthday.
If, for example, you had a DB pension paying £150,000 per year on your 75th birthday, this figure would be multiplied by 25 to determine how much lifetime allowance you had used up.
This only applies to funds crystallised before April 2006 – any DB benefits crystallised to pay a pension after this date would have been tested against the lifetime allowance at the time and would not be revisited at age 75.
You’d have used up £3.75m of your lifetime allowance (£150,000 x 25). As this is well above the current lifetime allowance of £1,055,000, the result would be a reduction in your available lifetime allowance to zero. The good news is that starting to take your DB pension before 2006 means there’s no charge on the excess over the lifetime allowance.
Assuming you had no ‘protections’ in place, the £270,000 you had invested in a SIPP would be subject to a lifetime allowance charge of 25% (£67,500) on your 75th birthday.
If you took it out of your SIPP as a lump sum before age 75 the charge would be 55% (£148,500). You wouldn’t be able to take any tax-free cash from your SIPP as this is only possible if you have remaining lifetime allowance, and yours would have been entirely used up by your DB scheme.
If you previously applied for ‘enhanced protection’ or ‘primary protection’ then it’s possible that some or all of the value of your SIPP would be shielded from a lifetime allowance charge. However, under the terms of enhanced protection you would not have been allowed to make any more pension contributions.
It’s also possible that you obtained lump sum protection in conjunction with either enhanced or primary protection, which would potentially allow you to retain your right to take up to a quarter of the SIPP as tax-free cash.
If you hold enhanced or primary protection but no lump sum protection it might still be possible to amend this so you could get at least some tax-free cash.
I would strongly recommend you speak to a regulated financial adviser to assess all your options.
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