LTA charge
The lifetime allowance charge is also designed to recoup tax relief on excess contributions made to the pension schemes. In the unfortunate cases where individuals have had multiple annual allowance charges and a large LTA charge, there could be a negative effect on some contributions. Advice should be taken in these circumstances to try and establish if continuing to contribute is worthwhile.
The LTA charge is tested at the point that benefits are crystallised. This is usually the point at which the funds are accessed and the tax-free cash is taken. However, it could alternatively be on death if the funds haven’t been crystallised before or at age 75. The amount tested each time uses up a percentage of the LTA, and it is only at the point that 100 per cent of the individual LTA has been used that a tax charge will apply.
The tax charge is either levied at 25 per cent or 55 per cent. The 25 per cent tax charge applies where the excess funds remain in the pension to provide an income. The reason it is lower is because it assumes that when the income is taken at a later date it will be subject to an income tax charge. The assumption is that this will be a charge at 40 per cent.
For example, apply a 25 per cent charge to £100,000 and the individual will be left with £75,000. Applying a 40 per cent income tax charge to the remainder would leave £45,000, which would be equal to an overall charge of 55 per cent on the original amount.
The 55 per cent charge is applied if funds greater than the LTA are taken out as a lump sum; there is no further income tax charge on this lump sum and hence a higher charge is levied.
All these charges could make some think that a pension isn’t a good investment, but that isn’t the case. Provided that the investments and payments into and out of a pension are made in the correct way and monitored to ensure they stay within the appropriate limits, their tax efficiency remains intact.
Taking the right advice about pensions and pension schemes is key to avoiding or minimising any tax charges due. The annual allowance and LTA charges may not be easy or possible to avoid in some cases, but opting out of a pension scheme isn’t something to take lightly.
Even with some tax charges applied, the benefits can outweigh the contributions paid in many cases. In addition, members of some schemes will also lose valuable death benefits, such as death-in-service payments, should they leave the scheme. All aspects need to be reviewed before any decision is made.
