Barrie Dawson: Winter is gone but the LTA freeze has arrived

clock • 4 min read

The frozen lifetime allowance for pension contributions is now in place. Here Barrie Dawson runs through some examples of what it could mean for clients

With the lifetime allowance (LTA) frozen until the end of the 2025/26 tax year, what does this mean for those who thought CPI increases would save them from LTA excess charges? Stating the obvious, it means that they may now end up incurring LTA charges, but tax charges aren't always a bad thing if the client ends up richer. What's crucial is that the calculations are revisited so that the client knows what to expect as a result of the freeze. There are lots of different scenarios that impact the calculations. Some will still be contributing/accruing further benefits and others will not, some will be partly or fully crystallised with LTA increases expected to manage the growth on a drawdown pot, which is tested against the LTA at age 75. There are too many permutations for this short article and no one size fits all solution.  However, let's consider a few scenarios for clients who will now exhaust their LTA and some of the planning considerations. Clients maintaining contributions to an occupational money purchase scheme Let's consider the impact of a £1,000 employee contribution, matched by their employer and will be above the LTA.
Total contribution LTA charge on designation to FAD* Residual Pot Net amount after 20% income tax Net amount after 40% income tax
£2,000 £500 £1,500 £1,200** £900**
*Flexible Access Drawdown ** No PCLS available on funds in excess of LTA If the member is a 40% taxpayer when making the contribution they are effectively paying £600 to achieve a net return of £900 if they are a 40% taxpayer when taking benefits or a £1,200 net return if they pay 20% tax. The key consideration in this example is whether or not this return could be achieved outside of the pension environment, particularly in view of the matching employer contribution.  If the client opted out of the pension would the employer increase their salary?  If so, this might provide a more suitable outcome but ultimately it will depend on each individual's circumstances and other investment options available. It's all about the net benefit if you are trying to increase your client's wealth. Clients who have stopped pension contributions but remain uncrystallised Let's consider a client whose plan is to retire on their 65th birthday in April 2030 and fully crystallise their money purchase pot using a FAD strategy. The calculations performed at their annual review in April 2020 were based on the assumption the LTA would increase by 0.5% each year until retirement in April 2030.  It was also projected their uncrystallised pot of £818,685 would grow by 3.5% net of charges to £1,115,784. The table below illustrates the results of the calculations prior to the LTA being frozen until the 2025/2026 tax year then the 0.5% increases begin again and no other changes.
LTA threshold April 2030 LTA excess PLCS payable LTA charge on designation to FAD FAD pot (after PCLS and LTA charge)
Pre LTA freeze £1,126,367 £0 £278,946 £0 £836,838
Post LTA freeze £1,094,724 £21,060 £273,681 £5,265 £836,838
In this example, the client would end up in the same place with regards to the value of their FAD pot but they'll receive £5,265 less PCLS than previously expected. Furthermore, the client has no more LTA available to set against any growth on the FAD pot if they reach age 75. A common question is should the client take benefits when they reach the LTA threshold. In the above scenario, this would mean taking benefits around eight months earlier and in the 2028/2029 tax year with an LTA threshold of £1,089,277. The client would receive lower PCLS of £272,319 and their FAD pot would be worth 816,957. However, based on the agreed growth rate the FAD pot would be roughly worth the same value come April 2030 but this increase would represent growth that would be tested against the LTA at age 75. Growth on FAD pot is tested against the LTA at age 75 but this growth can be managed by taking income. If the FAD pot at age 75 is equal to or less than the initial value, there's no further LTA used at age 75. Therefore, in either scenario, the FAD pot will be broadly the same at age 75. If the growth can't be managed by income then taking benefits when reaching the LTA would mean more growth at age 75 so a lower FAD value post 75 (and they would have received less PLCS). Remember, if death is before age 75 there's no further LTA test on the FAD pot (for clients that may have short life expectancy). The calculations here are key. Generally, the process is repeatable and can be broken down into the following six steps:
  1. Calculate existing benefits projected to retirement
  2. Calculate the overall cost of existing arrangements
  3. Calculate these benefits net of any taxes
  4. Calculate the value of "paid-up/deferred" benefits at retirement date
  5. Identify the value of alternate arrangements
  6. Identify the net benefit in retirement net of any taxes
Planning is individual, but mathematics is a universal constant. Add the value of the "paid-up"/deferred benefits to any alternative investments, compare that to step three in the process and whichever gives you the greater number is likely (based on assumptions) to make your client richer, LTA freeze or not. Barrie Dawson is technical manager at Prudential UK

More on Featured

Leeds Crown Court

Trustees plead guilty to £236,000 in illegal loans

Loans from workplace scheme transferred to sponsor

Hope William-Smith
clock 18 August 2022 • 1 min read
Chris Curry

'Vital' industry assists with connection to dashboards

Dashboard safety, security and effectiveness

Holly Roach
clock 17 August 2022 • 1 min read
Govt plans Civil Service pension early access age rise

Govt plans Civil Service pension early access age rise

Government reforms

Hope William-Smith
clock 16 August 2022 • 2 min read

In-depth

The pursuit of (post-acquisition) independence

The pursuit of (post-acquisition) independence

Acquirers 'want investment revenue'

Jon Yarker
clock 07 April 2022 • 8 min read
What should adviser firms do when a SIPP provider goes bust?

What should adviser firms do when a SIPP provider goes bust?

A port in a storm

Hannah Godfrey
clock 09 March 2022 • 7 min read
Return of the Provider: A vertical integration story

Return of the Provider: A vertical integration story

Eight providers and their advice arms

Tom Ellis
clock 02 March 2022 • 7 min read