Since 2012, the lifetime allowance (LTA) has been on a downwards trajectory.
Standing at £1.8m in 2010, the LTA has been systematically reduced to a current figure of £1m. But the next set of changes will see it move in the opposite direction.
The Finance Act 2016 legislated that the allowance would increase annually by consumer price inflation (CPI) as of April 2018, calculated from the previous September and rounded up to the nearest multiple of £100.
September’s CPI has now been confirmed as 3 per cent, meaning the LTA for the 2018-19 tax year will rise to £1.03m. Assuming current legislation does not change, regulations must be laid specifying the new figure before the start of the tax year – probably by mid-February.
What is the lifetime allowance?
The LTA is the maximum amount an individual can take from a pension without incurring a tax charge.
Other events, such as death before age 75 or transferring to a qualifying recognised overseas pension scheme (Qrops), also count towards the allowance.
If the excess over the LTA remains in the pension scheme, then a 25 per cent excess tax charge will be deducted. If the individual is under 75, it is also possible to take the excess as a lump sum, but at a 55 per cent tax charge.
Assuming the individual is a higher-rate taxpayer, and so the remaining money in the pension is eventually paid out as income taxable at 40 per cent, the two tax charges are broadly equivalent. See Box One.
Although the LTA has been cut every other year since April 2012, the original intention was that the opposite would happen, as occurred between April 2006 and April 2010. As such, the legislation in place since April 2006 is designed with increases in mind.
Revaluation of previous BCEs
Previous benefit crystallisation events (BCEs), such as taking pension benefits, will have used up a percentage of the LTA.
When the allowance changes, and assuming one of the various protections are not held, the percentage used stays the same. This has the effect of revaluing the previous BCE in line with changes in the lifetime allowance. See Box Two.
Reduction in LTA tax charges
Those who have no LTA protection and are above the current allowance of £1m will have their excess tax charge reduced by up to £16,500 (£30,000 x 55 per cent).
The maximum tax-free cash they could take could also increase by £7,500 (£30,000 x 25 per cent), saving a higher rate taxpayer a further £3,000 (£7,500 x 40 per cent).
Protection against the lifetime allowance
Various forms of protection against the LTA charge were made available upon its introduction in April 2006, with more added each time it was reduced.
Those with protection, other than the enhanced version, will continue to have an LTA that is the greater of either their protected LTA or the standard allowance.
For most people with protection, the increased figure will neither affect this nor any associated protected tax-free cash.
Scheme specific protected tax-free cash
Before 6 April 2006, the maximum tax-free cash that the Inland Revenue (now HMRC) rules permitted to be taken from an occupational scheme was, very broadly, based on salary and length of service.
As a result, it was possible for some scheme members to take more than 25 per cent, and in some cases up to 100 per cent of the fund.
To avoid retrospective taxation after April 2006, scheme members were able to protect the cash amount of tax-free cash in excess of 25 per cent, though various conditions applied.
The protected tax-free cash amount is:
• The tax-free cash as at 5 April 2006, adjusted by the increase from the 2006-07 LTA (£1.5m) to the underpinned LTA (£1.8m), plus
• 25 per cent of the increase in fund value, after revaluing the 5 April 2006 fund value, in line with the change in the standard LTA.
Although the formula itself is not straightforward, see Box Three, the end result is that the additional tax-free cash calculated under the second bullet point will drop when the LTA increases.
Therefore, if all else is equal, the protected tax-free cash will decrease. See Box Four.
For many, a pension fund of £1.03m will seem unobtainable. But those with larger pension funds, who are closer to retirement, a £30,000 uptick in the LTA will make a small, but welcome difference.
If the allowance continues to grow by 3 per cent a year, it would take roughly 24 years to reach £2m; a reminder of the compounding power of inflation. Whether the LTA will still exist in 24 years, let alone in 24 months, is another question.
Phil Warner is head of technical at Hargreaves Lansdown
