It’s possible to reduce the amount that will be tested against your remaining lifetime allowance at age 75 by taking income from your drawdown account, but it would require careful monitoring of your fund.
By the time you reach age 75, the lifetime allowance should be increasing, once again, in line with inflation so it should be higher than it is today, although there are no guarantees, and it may not keep up with investment growth.
This is important as it’ll be the lifetime allowance in force when you reach age 75 which will be used, not the current frozen one.
Your options
Taking out tax-free cash and no further income until age 75
Let’s assume you’ve taken out your 25pc tax-free cash sum at age 57 and the remaining funds in drawdown have grown by 2pc a year to £996,201 by the time you reach age 75. To keep it simple, and to show how the age 75 rule works, I’ve assumed you haven’t taken out any income. The investment growth of £298,701 (£996,201 – £697,500) will be tested against your remaining lifetime allowance.
If we also assume that the lifetime allowance will begin to increase again by 2pc per annum. from April 6 2026, it could be worth £1,415,932 by the time you reach age 75. You have 13.35pc of the lifetime allowance left, which at age 75 could be worth around £189,027.
If this is the case, you will have breached the lifetime allowance by £109,674 (£298,701- £189,027) at age 75. This excess would be subject to a lifetime allowance charge of 25pc, so £27,418.50, which your provider would deduct from your funds and pay to HM Revenue & Customs.
Taking out tax-free cash and income before age 75
By taking income you can reduce the value of your drawdown fund at age 75 and reduce the risk of breaching the lifetime allowance. Assuming you take out income of £100,000 just before the age 75 test is carried out, the fund value at age 75 would be approximately £100,000 lower, meaning the funds that exceed the lifetime allowance at age 75 will also be lower. This would reduce the lifetime allowance charge, and if you don’t use up 100pc of your lifetime allowance you wouldn’t face a tax charge at all.
It’s more likely that you’d want to take out smaller regular amounts, say £20,000 a year, gradually reducing the amount left in your drawdown fund. This will also reduce the amount to be tested at age 75. Doing this, with careful planning, could help reduce the risk of breaching the lifetime allowance at age 75.
Future pension contributions
Assuming you live in the UK, this may not be a suitable option if you want to pay further pension contributions later, as taking income from flexi-access drawdown triggers the money purchase annual allowance. This restricts tax relief on contributions to money purchase pensions to just £4,000 a year, including contributions paid by an employer. It may not be an issue now, but it’s worth considering. For example, if investments don’t perform as expected, you might want to top up your pension savings in the future.
Use your Isa allowance
Instead of paying into a pension, you could consider paying into other tax-efficient savings such as Isas. And if you do take your tax-free cash, you could pay some of this into your Isa. The good news is that there’s no lifetime allowance for Isa savings, so you can save as much as you like up to £20,000 a year.
There are many factors to consider – how much tax you’ll pay on the income, especially if you’re still working; inheritance tax if you don’t need to spend the income and it’s sitting in a bank account or an Isa when you die and whether you want to retain the ability to pay pension contributions of more than £4,000 a year.
Pensions doctor Kate Smith, of pension firm Aegon, solves your retirement issues. Write to Kate with your pension problem via pensionsdoctor@telegraph.co.uk. Columns are published twice a month on Tuesday mornings
