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Reduction in the lifetime allowance

This article is part of
Guide to Pensions Lifetime Allowance

The cut to the lifetime allowance will mean individuals who have not previously been granted primary, enhanced or fixed protection will potentially face a lifetime allowance charge on pension benefits in excess of £1.25m.

The lifetime allowance charge is 55 per cent if taken as a lump sum, or 25 per cent if taken as income.

HM Revenue & Customs has estimated the reduction in the lifetime allowance could potentially affect around 360,000 individuals, about 30,000 of whom will have pensions with a deemed value of between £1.25m and £1.5m in the 2014 to 2015 tax year.

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To understand whether your client may need to protect their pension pot it is vital that you calculate the value of their savings.

When benefits in a final salary scheme are crystallised, Mike Morrison, head of platform marketing of AJ Bell, says the annual amount of pension promised by the scheme is multiplied by a standard valuation factor of 20:1.

This factor includes an allowance for dependants’ benefits up to the level of the member’s pension at date of death and for annual increases of 5 per cent.

According to Mr Morrison any defined benefit scheme that provides better levels of dependants’ pensions or increases can apply to HMRC for a scheme specific valuation factor which can be higher than 20:1. Lump sums taken other than by commutation are valued using a factor of 1:1 and are added to the above value.

Benefits in payment are valued with a factor of 25:1, according to Mr Morrison.

Martin Tilley, director of technical services at Dentons, warns advisers that the changes to the lifetime allowance could impact more of their clients than they initially think.

An individual aged 50 with a current pension pot of only £525,000 will exceed the new £1.25m lifetime allowance with growth of just 6 per cent a year compound by the time they reach age 65, Mr Tilley warns.

He says: “Advisers should assess their younger but well funded pension clients.”

Ian Price, divisional director of pensions and consultancy at St James’s Place Wealth Management, says if individuals take action before the end of this tax year they can retain a lifetime allowance of £1.5m and save up to £137,500 in tax charges.

John Lawson, head of policy at Aviva, says advisers should also note there is an exception where the tax charge does not apply where the member dies before 6 April 2014, but payment of a lump sum death benefit is not made until on or after this date. In such a case the relevant pre-6 April 2014 limit applies.