How can I minimise tax on my pension?

Last year, I put an outsized chunk of my pension portfolio into some small UK oil exploration and production companies. That bet has paid off handsomely, but it means that I have now breached the 55 per cent tax threshold on my self invested personal pension (Sipp).

I am 48 years old, and so face another 20 years of capital growth in my Sipp that will ultimately be taxed at 55 per cent. How can I minimise my tax liability?

Should I become more conservative or more aggressive with the portion of my capital above the threshold? (I stand to make only 45 per cent of any gains, so perhaps I should be more cautious, but then again, I only suffer 45 per cent of any losses so perhaps I should be more aggressive). What advice would you give someone in my position?

Although your Sipp has now breached the £1m lifetime allowance threshold this does not mean that an immediate 55 per cent tax charge will result, says Gary Smith, chartered financial planner at Tilney. Your pension benefits will only be subject to a lifetime allowance check every time there is what HM Revenue & Customs refers to as a benefit crystallisation event.

While there are a number of these events, most won’t impact upon you until you are aged 55 or over, and in a position to commence drawing your retirement benefits. However, your pension benefits would be subject to a lifetime allowance test on your death, with any excess above £1m subject to a 55 per cent tax charge.

You could potentially minimise the future tax charge by applying for one of the protections that are currently available, these being; fixed protection 2016 and individual protection 2016.

Fixed protection 2016 enables someone to retain a lifetime allowance of £1.25m but this is only available to those who have not made any pension contributions after April 5 2016. If the value of your Sipp exceeded £1m on that date you could apply for individual protection 2016, and this would enable you to retain a lifetime allowance equivalent to the value of your Sipp, subject to a maximum of £1.25m.

Unlike fixed protection, you would still be able to make future contributions without revoking this protection. If you do qualify for either of these protections you will be able to apply directly through HMRC.

When you come to drawing your retirement benefits you can also control if, and when, any lifetime allowance tax charges are incurred. Let us assume you retire and the value of your Sipp is £2m and you require an annual income of £50,000, and that your lifetime allowance is only £1m. A lifetime allowance tax charge would only be incurred if the value of your retirement benefits exceed £1m and this can be avoided by only moving up to £1m of your Sipp into drawdown.

From this you could withdraw £50,000 per tax year (through a combination of income and tax-free cash) until the monies were exhausted. It is only if you move any additional funds into drawdown that a lifetime allowance tax charge would be incurred. Your Sipp would be also be tested against the lifetime allowance on your 75th birthday, with any uninvested money (ie money not in drawdown) subject to the 55 per cent tax charge.

You also need to consider that the chancellor has confirmed the lifetime allowance will increase in line with the Consumer Prices Index from April 2018 and, there is no guarantee that it will even remain in the future, as legislation can, and has historically changed.

As for the level of investment risk to be adopted within your Sipp, you need to consider what level of income you will require in retirement and when you actually want to retire, adds Les Cameron, pensions expert at Prudential. Crucially, you need to be happy that if any risks you take go against you, any loss would not have a material impact on your circumstances.

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It appears that you were comfortable being adventurous given that you describe this as a “bet”. The ongoing issue is whether you want to cash in that bet or keep it in play. Given the tax liability at the end you will not see all the reward for the risk you will be taking, which could change your attitude. You need to decide whether this has changed your attitude to risk, and then invest appropriately.

The main purpose of a pension is ultimately to provide you with an income in retirement. It is important you assess what you will need to spend in retirement and how much of your pension is required to provide this. You may then choose to invest the amount you need for your retirement more conservatively and be riskier with the “spare capital”.

The opinions in this column are intended for general information purposes only and should not be used as a substitute for professional advice. The Financial Times Ltd and the authors are not responsible for any direct or indirect result arising from any reliance placed on replies, including any loss, and exclude liability to the full extent.

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