Pension Benefit Deferral Beyond Age 75 – An Opportunity Not To Be Overlooked.

08/09/2011

It is good news that merely passing age 75 no longer inhibits payment of Tax Free Cash and in most cases taking benefits will often be more suitable than deferral and show the value of advice and a well-defined financial plan, linked to specific objectives.

However, we would like to consider who could benefit from deferral and what are the implications and opportunities arising from this recent change in pension legislation?

Most of those looking for planning opportunities from this change will be high net worth individuals, who will have a range of options for supporting themselves in old age and who, won’t be relying exclusively on their pension funds, and who may hope to obtain a higher Tax Free Cash sum and benefit from tax efficient growth in the meantime.   Alternatively, maybe, the pension holder would like to pass the pension fund on to beneficiaries free of Inheritance Tax (IHT), or it could simply be that they just don’t need the money now and see no reason to commence taking benefits. 

However it is important to note that the deferral route includes potential traps for the unwary which are as follows:

• All benefits, including TFC must be tested against the lifetime allowance by age 75.

• Any payment of benefits after 75 is still subject to a check to ensure that tax-free cash stays within the usual limits of up to 25% of the lifetime allowance, as if the member were still below 75. HMRC call this limit the ‘available portion’. Where the lifetime allowance is used up, no further TFC can accrue after age 75.

• Where TFC is limited to the available portion, more of the returns after 75 may ultimately have to provide a taxable income.

• Once the member reaches age 75, any excess over the lifetime allowance can’t be paid as a taxable lump sum.

• Residual funds paid as a lump sum on death are subject to 55% tax – including any that could have been paid as TFC during lifetime and/or that have already suffered a lifetime allowance excess tax charge.

• Whereas the worst case scenario for cash paid during lifetime is 40% IHT as part of the deceased’s estate. Of course there is no IHT on transfers between spouses.

• After 75, TFC must still be paid alongside a relevant pension benefit. Both capped and flexible drawdown count as relevant pensions.

• The fund and TFC could fall in absolute and real terms.

THE IMPLICATIONS AND OPPORTUNITIES

Naturally the deferral decision depends on each individual’s particular circumstances and objectives.

Occasionally deferral may be useful in certain specific cases. Take a SSAS for example. There could be complications arising from difficulties in disinvesting illiquid assets to pay benefits, the nature of the ‘pooled’ fund and the impact on other scheme members, which make temporary deferral more attractive within the pension scheme.

However, special cases aside, many individual’s will probably want to consider the cost of passing up the TFC opportunity. At best this may be the lost opportunity to enjoy the use of the capital while health is relatively good. At worst it may translate to loss of capital via poor investment, inflation tax or a combination of all three.

It is important also to consider the risk profile required to make continued investment viable and the cost in terms of lost income opportunities as well as deferring capital. This may be difficult to justify for someone of advancing years and will depend on each individuals’ circumstances and attitude to risk.

But what if maintaining the real value of capital and income is not a priority over preserving funds for potential beneficiaries now or in the future?

Withdrawing pension money alongside suitable estate planning strategies may still be better than allowing all the hard-earned tax relief to be clawed back via the 55% tax charge.

A single premium investment bond within an appropriate loan or discounted income and gift trust is an obvious example of an alternative investment for a client’s TFC that can deliver tax efficient growth, income and estate planning opportunities.

After taking TFC, one could utilise the new capped or flexible drawdown rules, subject to meeting the minimum income requirement (MIR).  One could use part of their pension funds to buy an annuity to meet the Minimum Income Requirement, or if there are other sources of secure pension income this may satisfy flexible drawdown’s £20,000 per annum minimum income requirement (MIR) without significant annuity purchase being necessary.

One could also consider making regular gifts out of income. (Flexible drawdown could satisfy HMRC conditions for surplus income, if taken on a staged basis.) Surplus income could even be recycled as tax-relievable third party pension contributions to any number of children’s/grandchildren’s pensions and would not breach flexible drawdown rules that inhibit subsequent pension contributions.

To conclude, we believe the most important message is that there is now even more choice for those with retirement funds and in this respect probably even more need to seek independent financial advice firstly, whilst building your pension fund throughout life and secondly, before vesting any pension contracts in retirement.

Paul Dixon
Chartered Financial Planner