Techzone

75 is a momentous age for pension savers. Larger funds could be subject to the LTA charge at 75, and beyond 75 contributions no longer attract tax relief and death benefits will ultimately become taxable.

While nothing can be done to avoid any of these events, their impact can be minimised with the appropriate advice, ensuring that your clients and their families are able to maximise the benefits available to them after a lifetime of saving.

Is your client in the right scheme?

‘Pension freedoms’ are all about giving people the flexibility and choice over how they take their retirement benefits, as well as who can inherit any death benefits and how these can be taken. The choices made will also be influenced by a desire to minimise any tax paid.

It’s important then that clients make sure that they're in a pension scheme that can deliver these flexibilities.

This should be done as soon as possible – after all, none of us knows what lies around the corner – but certainly before reaching age 75, when a transfer may no longer be possible in some cases and certain options over benefits may be lost forever.

For example, after taking tax free cash, some schemes will require the member to buy an annuity or take a scheme pension with the balance.

Transferring does of course come with an IHT warning. For most people, a transfer made while in good health will have no implications. But there could be a sting in the tail for those who leave it until their health is failing. Should they die within two years of transfer, a value may be placed on the transfer itself, which could result in  IHT becoming due. This is why transfers to modern flexible schemes should be done before health becomes an issue.

Lifetime allowance (LTA) – the order of testing benefits

Some individuals may have several pension schemes that have not yet been crystallised as they approach 75. These will be subject to a lifetime allowance test at 75, along with any growth on funds that have been crystallised but left in a drawdown account.

If the total value to be tested is over the LTA, thought should be given to the order in which each scheme is tested. That’s not to say that schemes must actually be crystallised before 75 in the desired order. Fortunately, clients can choose the order they are tested at 75, as long as all scheme providers are kept informed.

The order of testing can make a difference, even though the LTA charge remains 25% of the excess. Primarily, it will determine which schemes actually have to pay the charge. Those tested first, if within the LTA, won’t have to share any of the tax burden. This can matter in the following ways:

• If a defined benefit (DB) scheme becomes liable to the charge, the scheme administrators will pay the charge, but will reduce the scheme benefits due according to the commutation factor of the scheme. For example, if the commutation factor is 1:15, the pension would be reduced by £1 for every £15 of tax the scheme has to pay to HMRC. If the client thinks that this doesn’t look like good value for money and has both DB benefits and money purchase benefits, they may wish to have the DB benefits tested first, leaving the money purchase savings to bear the LTA charge.
• If someone has scheme specific tax free cash protection greater than 25%, this can only be preserved if it falls within the LTA when tested. It may therefore be necessary to consider the order in which benefits are crystallised to maximise tax free cash.
• Clients with several plans at 75 may have a preferred scheme because it offers greater fund choice, better functionality and administration or lower charges. This may be reason enough to push the LTA charge on to less favoured schemes.
• Some clients may still have savings in a plan with a guaranteed annuity rate and therefore prefer the LTA charge to come out of other plans.

Death benefit nominations

Age 75 marks a significant change in the taxation of death benefits – generally they’re free from income tax on death before 75, but subject to income tax post 75. This should prompt a review of death benefit nominations, particularly where benefits have been nominated to be paid to a trust.

Lumps sums paid to a trust on death after the member's 75th birthday will have 45% tax* deducted by the pension provider. This means that only 55% of the remaining funds will be available for investment by the trustees.

Alternatively, if the beneficiary inherits the pension pot, the full amount is invested and they will only pay income tax as and when they draw money from it. So, unless they’re going to take all the benefits immediately, there will be larger funds invested for longer, giving the potential for more growth.

While the tax argument for inheriting post 75 death benefits under a pension is strong, there could also be equally strong non-tax arguments for paying them to trust. Paying to a trust means the member can choose their own trustees and therefore control  who benefits from the death benefits and when.

However, it may be that by age 75, any concerns a member may have had about beneficiaries in the past have diminished, making death benefit nominations more straightforward.

* The 45% tax deducted is available to act as a tax credit with payments made from the death benefits to the beneficiary and any overpayments of tax can be reclaimed.

Tax free cash

Although legislation allows individuals to delay taking tax free cash beyond age 75, not all schemes will allow this. This is another reason for ensuring that clients are in a scheme that gives the options that they want.

Where this is an option, if a client dies after reaching age 75 but before taking their tax free cash, the remaining funds would all be subject to income tax at the beneficiary’s marginal rate. The tax free cash can only be taken by the original member.

That’s not to say that tax free cash should always be taken either before or after age 75. Taking tax free cash from the pension will potentially expose it to 40% IHT in the estate unless it’s actually ‘spent’ or gifted and outside the estate when the member dies.

If the client doesn’t need the benefits, they could be left in the pension and inherited by beneficiaries on death, who may be able to access the funds as and when they want at lower rates of tax.

So if clients don’t need their tax free cash for a specific purpose, the question they should ask themselves is ‘Which route is likely to result in the lowest tax charge, given their particular circumstances?’

For those with benefits in excess of the LTA, tax free cash is an area where particular care is needed, to ensure that clients don’t lose out. Here are a few examples:

• Scheme specific tax free cash
  Tax free cash is usually limited to 25% of the remaining LTA. However, where a client has scheme specific tax free cash protection allowing more than 25%, this can be paid as long as the tax free cash itself is within the remaining LTA. Leaving such a scheme until there was no, or insufficient, LTA left would result in receiving less tax free cash overall.
  
  
• Pension sharing on divorce
  Clients who have received a pension credit from an ex-spouse’s pension that had already come into payment post A-Day (known as a ‘disqualifying pension credit’) won’t be entitled to any tax free cash from those funds. So, all other things being equal, it can make sense to have these benefits tested last to avoid using up LTA and restricting tax free cash from other schemes.
  
  
• Deferring tax free cash beyond 75 where other funds already in drawdown
  Whilst tax free cash can be taken beyond age 75 from ‘unused funds’, care is needed. If other funds were in drawdown before age 75, any growth on those funds is tested against the LTA at age 75 and can use up available LTA. This can have the knock on effect of restricting the amount of tax free cash that can subsequently be taken from the ‘unused funds’.

Pension funding

Tax relief on personal contributions to pensions ends at age 75. Just before reaching 75 may therefore be an opportunity to boost their pension and get tax relief. Business owners who still have relevant UK earnings are perhaps the most likely clients to take advantage of this.

Contributions for those with no earnings is limited to £3,600 gross.

Investment decisions

For those who had LTA issues and are perhaps less concerned about running out of money in retirement, reaching age 75 could be a time to review pension investment decisions. Some clients may have de-risked their pensions pre-75 knowing that they may have only benefited from 45% of any growth over the LTA whilst suffering 100% of any drop in value.

But after reaching age 75, growth is no longer an issue – clients will get 100% of any upswing in value.

Summary

Being ahead of the game as a client approaches age 75 will give you time to ensure that they’re in the right contract for their needs and, where benefits are in excess of the LTA, that a plan can be put in place (and providers notified) to test the benefits in the order which will give the best outcome for the client and their beneficiaries.

Leaving it to chance could limit choices and have significant tax consequences.