How to pick the most appropriate strategy for you
Reducing the value of any LTA tax charge paid is often desired by clients but whether this is the most appropriate strategy depends on the client's circumstances and objectives.
Pensions are usually outside of an estate for the purposes of inheritance tax, which means that for clients with an estate that already exceeds the inheritance tax nil-rate band (the amount that can be passed on without paying tax), any assets that are moved from a pension environment to a non-pension environment, and then passed on, will have a 40% inheritance tax charge applied to them.
As we looked at in the last section, the LTA tax charge may be as little as 25% and in some cases therefore, it is worth considering leaving the assets within the pension, knowing that a 25% LTA tax charge will be due but it is lower than a 40% inheritance tax charge that would otherwise be paid if the funds were taken out of the pension.
Crystallise the entire pension
When might it be appropriate?
A lump sum or income is required now
The pension makes up the majority of your overall assets
Estate planning is not a concern
When you approach or hit the LTA, crystallising 100% of the pension can help reduce the overall tax burden, and it allows you to receive the maximum possible tax-free lump sum.
Between the initial crystallisation and age 75, growth in the crystallised fund can also be withdrawn which can alleviate the need to pay any LTA tax charge.
That said, this strategy could mean bringing lots of capital into your estate so it may not be wise to do so if the capital is not required.
Partially crystallise
Some lump sum cash is required now
Moves only the portion required for income into your estate
You wish to continue to grow the pension
If your pension is below the LTA, partial crystallisations can result in a better overall outcome.
After each crystallisation, the funds that remain uncrystallised can continue to grow which increases the value of the sum that can be taken tax-free at a later date. It also delays bringing funds into your estate for the purposes of inheritance tax.
Lastly, if more funds are taken from the pension in the form of tax-free cash than is actually needed you may decide to reinvest some of the proceeds in a General Investment Account, which is taxable, and will result in worse net returns compared to remaining invested in the pension.
Leave the pension
You do not require a lump sum or income from the pension
You are using the pension for estate planning
You have sizeable taxable assets to live on
If you wish to use your pension assets to pass on to your beneficiaries, then retaining funds in the pension may offer the best outcome.
Funds that remain invested within the pension continue to grow free of income and capital gains tax and the pension remains outside of your estate for inheritance tax purposes.
This means that the eventual LTA tax charge grows but this LTA tax charge will be 25% and this may therefore be more preferable than your beneficiaries paying 40% inheritance tax.
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