I turned 70 last month and haven’t yet started taking an income from my pension. My fund enjoyed 20% growth last year and as a result I’m perilously close to the lifetime allowance. I’m thinking about withdrawing some money from my SIPP and putting it in an ISA to keep below the lifetime allowance as my 75th birthday approaches. Is this sensible?

Robert

As with many things in this complicated part of pensions, the answer is ‘it depends on your circumstances’.

The lifetime allowance, currently set at £1,073,100, is designed to limit the amount you can save tax-efficiently in UK pensions. If you breach your lifetime allowance you will pay a lifetime allowance charge on the excess.

This lifetime allowance charge will be:

25% if you leave the excess in your pension and take it as an income, with income tax levied on top of that;

55% if you take the excess as a lump sum, with no income tax due.

There are a number of ‘benefit crystallisation events’ that trigger a lifetime allowance test, including taking your 25% tax-free cash, buying an annuity or entering drawdown.

There is also a test at age 75 which is designed to capture any growth in your crystallised fund value, plus any as-yet uncrystallised funds you have.

For example, at age 70 someone might have crystallised £750,000 in drawdown and £250,000 by taking their 25% tax-free cash – £1 million in total. This would use up 93.18% of their lifetime allowance (assuming they are entitled to the standard lifetime allowance of £1,073,100).

If over the next five years their fund increases in value to £1.3 million then the age 75 test will capture that growth – meaning a lifetime allowance charge would be payable.

The simple answer to the question ‘could you take money out of a pension to avoid the age 75 test’ is ‘yes’. However, whether that will benefit you or not will depend on your circumstances. You certainly won’t be able to dodge the lifetime allowance test altogether.

If your investments have gone up by 20% in single year that suggests you’ve taken a fair amount of risk – and therefore your investments could also fall in value significantly in any given year. If this happens, a large withdrawal designed to reduce your tax burden may in fact increase your tax burden.

This is probably easiest to illustrate with an example. Take someone aged 74 with a crystallised £1.2 million fund who withdraws £200,000 to avoid paying a lifetime allowance charge on their drawdown fund at age 75.

For simplicity, let’s assume this is their only income and so they pay almost £70,000 in income tax – including paying higher and additional-rate tax on portions of the withdrawal.

Over the year their investments drop in value by 20%. Based on the original value of £1.2 million, this would imply at age 75 their fund would have been worth £960,000 had they done nothing – well below the lifetime allowance.

They could then have managed their income after the age of 75 to minimise their tax liability – for example by ensuring they never pay more than basic-rate income tax.

If passing money onto loved ones is a consideration, you should also bear in mind that pensions are usually free from inheritance tax and can be passed on tax-free to loved ones if you die before age 75. After age 75, income tax is payable at the beneficiary’s appropriate rate – but withdrawals can be managed to minimise the tax due.

Money held in an ISA, on the other hand, is always free of income tax but will form part of your estate for IHT purposes (although it is possible to gift money while you’re alive to reduce any potential IHT bill).

In short, this is far from straightforward and whether your approach reduces the amount of tax you pay will depend on circumstances.

For this reason, I’d strongly recommend engaging the services of a regulated adviser, who can help you make the best decision based on a review of your entire financial position.

DO YOU HAVE A QUESTION ON RETIREMENT ISSUES?

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

Please note, we only provide information 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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