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How much more tax free cash can I take?

Kay Ingram helps a reader work out how much tax free cash they are entitled to take
How much more tax free cash can I take?

When I took my final salary pension in March 2020 I was offered £236,000 as a tax-free lump sum, but chose to take only £200,000 believing that I could take the balance – up to 25 per cent of the Lifetime Allowance (LTA) – from my other pension pots. Is this correct?

In addition to my final salary scheme, which equates to 92.53 per cent of the LTA, I have around £232,000 in a self invested personal pension and £50,000 in a defined contribution (DC) pension. I have not yet drawn from either but when I do will I be able to take around £68,000 tax free?

H McG

The LTA is a cumulative allowance applied to all your UK private pensions. Up to 25 per cent of the available allowance can be withdrawn as a tax-free lump sum. But withdrawals over this, whether taken as a regular income or a one-off amount, are taxed as income at the taxpayer’s marginal rate in the year of payment.

Assuming that you have no lump sum protection in place with HM Revenue & Customs and are relying on the standard LTA (£1,073,100), the maximum tax-free lump sum you can withdraw from your remaining pensions is likely to be £20,040. There is no carry forward of any tax-free lump sum not taken from one scheme to another.

As each pension is crystallised, the holder uses a percentage of the lifetime allowance. Your final salary scheme has used up 92.53 per cent of the allowance, leaving 7.47 per cent available, currently worth £80,160, and 25 per cent of this is £20,040. The LTA is now frozen until 2026 but may be increased thereafter so the 7.47 per cent remaining could be a higher sum in the future.

 

Protected Lifetime Allowance and Protected Lump Sums

There may be scope for you to increase the LTA available to you. You may still be eligible to apply for Fixed Protection 16 (FP16) or Individual Protection 16 (IP16). FP 16 gives a fixed £1.25mn LTA. To be eligible you must not have made, or received, pension contributions or pension accrual after 5 April 2016. If ineligible for FP16, you may apply for IP16, if on 5 April 2016, the LTA value of your pensions was £1mn or more. The value at that date, up to a cap of £1.25mn, gives a protected LTA.

If, on 5 April 2006, you had a lump sum entitlement of more than £375,000 you could have applied for lump sum protection which gave a higher percentage of the standard 25 per cent of the LTA. Applications for this closed in 2009.

If your DC scheme was an occupational pension which, on 5 April 2006, gave you a tax-free lump sum entitlement of more than 25 per cent of the fund value, you may have scheme specific protection enabling a higher percentage lump sum from that scheme. There is no formal application process for this. It is most likely to arise where the scheme membership started before mid-1989. The overall LTA still applies. Transferring away from the scheme would lose any scheme specific lump sum protection.

Applying the standard LTA, there is likely to be a lifetime allowance charge on some of your remaining DC pensions as the total value of £282,000 exceeds the remaining LTA of £80,160. Your pensions are tested against the LTA when you withdraw money or reach age 75, or your death before that age.

The tax charge on the excess over the LTA is 25 per cent if you leave the pensions invested beyond age 75, with income tax then payable on any withdrawals you make. Alternatively, you may choose to withdraw the excess as a lump sum, paying 55 per cent tax on the excess. The 45 per cent balance of the excess would be paid to you with no further tax to pay.

It is worth remembering that the LTA charge is a one-off tax and after age 75 no further tax charges apply to your pension pots unless and until you make withdrawals, taxed as income. Growth within the fund is tax free and any funds left on death remain outside your taxable estate for inheritance tax purposes.

Providing that your pension plans allow it, any remaining fund on your death may be passed on to your nominated successors. The fund can continue to grow tax-free and your nominated successors can withdraw from it or leave it untouched. Inherited pension pots do not count towards their LTAs and may be passed on several times until the pot is exhausted. If you die before age 75 any withdrawals your successors make are tax free but otherwise taxed as their income. If your pensions don’t offer this option and you wish to leave them invested beyond age 75, consider transferring them into a plan that does.

Taxation legislation is complex and may be subject to future changes. Anyone with pensions near or above the LTA should consider seeking regulated advice.