Much as theatregoers often have little idea of the work that goes on behind the scenes, the same can be applied to most business activities.
For example, while the latest pension changes brought a welcome relaxation in the rules governing the taking of retirement benefits, pension providers and advisers had relatively little time to prepare for them. This article takes a look at an ongoing task that is required for the smooth-running of pension funds and in particular the taking of retirement benefits – which for the vast majority of members has no impact whatsoever.
Benefit crystallisation events, or BCEs, are part of the mechanism by which Revenue & Customs controls and, if applicable, restricts tax reliefs on pensions. Most individuals are, however, totally unaware of the existence of BCEs as they are normally well within the limits set.
The lifetime allowance is the total amount an individual can save tax-efficiently to their pension. The current LTA limit is £1.25m, although higher limits may have been previously protected.
An LTA charge applies to the crystallised amount over and above a member’s LTA. For defined contribution schemes the amount due is calculated on the value of the fund, while for a scheme pension it is calculated by applying a factor of 20.1 to each £1 of pension.
An LTA check is needed when benefits are taken, or upon transfer to a qualifying recognised overseas pension schemeThe charge is 55 per cent if the chargeable amount is taken as a lump sum, or 25 per cent if the chargeable amount is taken as income, such as a pension payment or cash withdrawal. It can only be paid as an income if the member is over 75. Any income is then subject to income tax at the member’s marginal rate.
This means that the overall tax charge is about the same whether paid as a lump sum or as income for a higher-rate taxpayer. For example, taking a chargeable amount of £100,000 as a lump sum would result in a tax charge of 55 per cent, leaving £45,000 net. For income, the tax charge would be 25 per cent, leaving £75,000 net.
This income would then be taxed at 40 per cent, leaving £45,000 net, so the same as for a lump sum. The difference is in the timing of the payment of the tax. However, the tax situation is better for a basic-rate taxpayer but worse for an additional-rate taxpayer.
An LTA check is needed when benefits are taken (crystallised), or upon transfer to a qualifying recognised overseas pension scheme. This procedure is known as a benefit crystallisation event and there are 13 different events (see table).
| BCE1 | Money purchase funds are designated for drawdown (including short-term annuities) before age 75. |
| BCE2 | Where a member becomes entitled to a scheme pension before age 75. |
| BCE3 | A scheme pension in payment is increased beyond a permitted level. |
| BCE4 | Where a member becomes entitled to a lifetime annuity before age 75. |
| BCE5 | Where a member reaches age 75 under a defined benefit scheme without taking benefits. |
| BCE5a | Where a member reaches age 75 with a drawdown fund. |
| BCE5b | Reaching age 75 under a money purchase arrangement without taking benefits. |
| BCE5c | Where a member dies before age 75 and his/her uncrystallised funds are designated for a dependent’s or nominee’s flexi-access drawdown within the relevant two-year period. |
| BCE5d | Where a member dies before age 75 and his/her uncrystallised funds are used to purchase a dependent’s or nominee’s annuity within the relevant two-year period. |
| BCE6 | Where a member becomes entitled to a relevant lump sum (for example pension commencement lump sum). This BCE is normally in addition to BC1, BC2 or BC4. An uncrystallised funds pension lump sum (UFPLS) will be covered by this BCE. |
| BCE7 | Payment of a relevant lump sum death benefit from a defined benefit scheme or an uncrystallised money purchase arrangement before age 75. |
| BCE8 | Transfer to a QROPS. |
| BCE9 | Certain payments (other than those above) are made that are authorised payments. |
When a fund is crystallised, a statement showing the percentage of the LTA that has been used will be issued to the member. It is the member’s responsibility to keep this and include this information in any subsequent request to crystallise further benefits.
Every provider has the responsibility to check that the percentage of LTA being used together with that already used up does not exceed 100 per cent. Percentages are used rather than monetary amounts, as a percentage used can then be taken into account in the future, regardless of the LTA changing.
Where funds have been previously tested against BCE1 and are then subsequently tested against another BCE – for example, if funds initially went into drawdown and the member then reached age 75 or purchased an annuity – an allowance is made for funds previously tested. This is to ensure the same funds are not tested more than once.
Consideration should be given around the timing of benefits, especially where an individual has benefits within a defined benefit scheme. BCE 6, which refers to the payment of a pension commencement lump sum, is normally deemed to be taken first and for clients with benefits close to the lifetime allowance it may be possible to take advantage of this in order to mitigate or avoid paying a lifetime allowance charge.
Defined benefits are valued based on a calculation of 20 times the scheme pension, so this can sometimes give a much larger figure than the alternative valuation of taking a reduced pension and tax-free cash.
The tax-free cash will be based on a commutation factor, for example, 12 or 15, where for each £15 or £12 of tax-free cash taken, £1 of pension is given up. By taking the maximum tax-free cash or where there are two schemes crystallising, taking the benefits with the lower commutation factor first, it is possible to mitigate some or all of any lifetime allowance charge
All of the BCEs occur before a member reaches age 75, the only exception being BCE3 (increase in scheme pension beyond the permitted level), which can occur on or after age 75. While a BCE does not apply for death benefits on or after age 75, any lump sums payable are currently subject to the special lump-sum death benefits charge of 45 per cent. This is planned to be reduced to the beneficiary’s marginal rate of income tax from April 2016.
Monitoring and reporting responsibilities are split between the member and the scheme.
The scheme administrator is responsible for:
• checking whether a chargeable amount arises and if so, issuing an appropriate notice for the member to use for self-assessment;
• accounting for any tax to HMRC;
• providing the member with a BCE statement.
The member must provide any evidence as required by a scheme administrator. For example, a copy of the statement showing the percentage of lifetime allowance already utilised.
The member and scheme administrator are jointly responsible and liable for any LTA charge, although in practice the scheme administrator will pay the charge with the member noting it on his/her self-assessment. If a chargeable amount occurs as a result of the death of a member, the liability rests with the recipient of the lump sum.
Checking of pension funds against the LTA is an important function that all providers carry out when BCEs occur. BCEs impact all individuals who have a pension fund, but for the majority it is purely an administrative check to comply with; it is only a relative few who will find themselves subject to an LTA tax charge.
Of course, if the LTA remains at £1.25m, or perhaps reduces still further, then over time more people will be subject to the charge. Then there is the possibility, as currently being lobbied for, that the LTA will be abolished.
Colin Batchelor is pensions consultant at Canada Life
Key Points
Pension providers and advisers had relatively little time to prepare for the pension changes announced last year.
When a fund is crystallised, a statement showing the percentage of the LTA that has been used will be issued to the member.
Checking of pension funds against the LTA is an important function that all providers carry out when BCEs occur.
