Case Study: Exceeding the lifetime allowance

Gordon is 65 years old when he retires with a pension fund of £1.5 million. He is able to take 25% of the Lifetime Allowance as a tax-free lump sum (£250,000) and the balance (£750,000) is designated to provide income.

His pension fund is £500,000 over the £1 million Lifetime Allowance so he also pays a 25% Lifetime Allowance Charge, leaving £375,000 net ‘excess’. He leaves this part of his fund invested.

Gordon dies two years later aged 67. His total estate is valued at £3 million so his non-pension assets are subject to Inheritance Tax. As he was under 75 when he died, his remaining pension funds go straight to his grandchildren without any further tax. The rest of his estate is subject to 40% IHT.

The grandchildren receive the net excess amount (£375,000) without having to pay any more tax. If Gordon had stopped saving into a pension and accumulated £500,000 in cash saving the money would have been subject to Inheritance Tax at 40% – his grandchildren would have received £300,000.

If Gordon had died after reaching age 75 his grandchildren would have paid tax on the pension they inherited, but only when they decided to take out the money. As they are both students, they can use their tax-free Personal Allowance to draw £11,000 each from the remaining pension fund without paying any tax.

Gordon could have decided to stop contributing money to his pension and save the money in a deposit account in order to avoid the Lifetime Allowance Charge. By doing so he would have forfeited the up-front tax relief available on pension contributions. Gordon was a higher rate taxpayer, so a contribution of £500,000 effectively ‘cost’ him £300,000 (ignoring the effect of tax-free growth).

The following table compares the net proceeds in the hands of Gordon’s beneficiaries:

Pension Cash
Amount £500,000 £300,000
Net of 25% LTA Charge £375,000
Net of 40% IHT £180,000
Death after 75 £375,000
Non taxpayer £375,000
Basic rate taxpayer £300,000
Higher rate taxpayer £225,000

 

By continuing to make tax relievable pension contributions Gordon has the potential to pass on more than double the amount he would have been able to save into a bank account.

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