Seeking help with a pensions allowance calculation
I’m 56, have a SIPP and want to retire in 2028, so I’ve started looking at the lifetime allowance cap.
If my SIPP exceeded the current value of £1,073,100 to say a value of £1,500,000, would the 25% tax-free amount for withdrawals be based on the cap or my total pot size?
Tom Selby, AJ Bell Senior Analyst says:
Usually the maximum tax-free cash you can take from your pension is limited by the lifetime allowance. This means in 2020/21 someone ‘crystallising’ their retirement pot could be entitled to up to £268,275 in tax-free cash (25% of the current lifetime allowance of £1,073,100).
‘Crystallising’ your pension just means choosing a retirement income option, such as entering drawdown or buying an annuity.
You need to do this in order to unlock your tax-free cash, at which point HMRC will test how much lifetime allowance you have used.
Since 2018/19 the lifetime allowance has been linked to consumer prices index (CPI) inflation. Given you plan to retire in 2028, that could have a significant impact on both your available lifetime allowance and consequently your tax-free cash entitlement.
For example, if CPI runs at 2% a year – in line with the Bank of England’s target – then by 2028 the lifetime allowance could be worth north of £1,250,000, implying a tax-free cash entitlement of at least £312,500.
The actual lifetime allowance and tax-free cash available to you will depend on what happens to CPI and government tax policy – neither of which can be guaranteed.
There are circumstances where someone could have a tax-free cash entitlement worth more than 25% of the current lifetime allowance.
The lifetime allowance was introduced on 6 April 2006 (a point known as A-day) and at the time was set at £1.5 million, implying a maximum tax-free cash entitlement of £375,000.
Because some people had already built up a tax-free cash entitlement worth more than £375,000 at that point, rules were introduced to allow people to protect this entitlement.
Those who claimed ‘primary’ protection were able to have the monetary amount of their tax-free cash rights at 5 April 2006 protected (subject to upward indexing).
Those who claimed ‘enhanced’ protection were able to have their tax-free cash protection quoted as a percentage of their fund, rather than a monetary value.
Certain types of pension scheme also offered tax-free cash entitlement worth more than 25% of the fund value prior to A-day. Where this was the case, ‘scheme specific’ protection may have been offered, allowing the member to maintain their pre-A-day entitlement.
Lifetime allowance ‘fixed’ protection and ‘individual’ protection regimes were also made available each time the lifetime allowance was cut in 2012, 2014 and 2016. Those who successfully applied for one of these protections were entitled to 25% tax-free cash based on their protected lifetime allowance amount.
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