Not strictly an investing topic I know, but during a recent discussion thread a couple of us thought it would be helpful to find out to what extent others had considered the income tax implications of the new(ish) lower lifetime allowance limit (LA) limit. Please note that my post is based on a laymans rather than a qualified experts view and if you have any concerns you should seek professional financial advice. 

Most will be aware that the LA applies to all DC and DB pensions and is designed so that a significantly higher income tax rate (55%) is applied to cumulative drawings in excess of the LA limit (currently £1.055m but rising in line with CPI). My understanding is that the limit is tested each time there is  crystallisation event (normally a drawing under your pension) but also critically is automatically tested against the balance of monies in your schemes at age 75.

Using a simple spreadsheet I ran a number of scenarios one of which is as follows. A 55 year old has a pension pot of £600k (remember you have to add any DB scheme, multiplying the estimated annual income by 20 times, to the DC total). She/he continues to contribute 12% of their annual salary of £75pa until age 66. At age 67 they begin to drawdown 4% p.a. of their then pension pot. Assuming that their returns during the 20 years to age 75 average 2.5% above inflation or less they will not have a significant LA related  tax charge. However that average return only needs to go up to 3% above inflation for a £100k tax bill to be payable at age 75. Based on many threads the average Stocko subscriber is achieving well above inflation plus 2.5% returns. The thing that surprises me is that the potential size of your tax bill is very sensitive to even small changes in the investment return. At the same time the test at 75 affects the usefulness of a SIPP as a mechanism for sheltering an estate against IHT.

Of course I may be misconstruing the way in which the LA is applied and would be interested to find out what conclusions others had reached and what strategies they were employing. 


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