Defined Contribution  

Testing DC pension benefits against the lifetime allowance

  • List the calculations involved in testing against the lifetime allowance.
  • Describe how the tax charge is calculated and whether there is any way of mitigating it.
  • Identify how pre-2006 pensions can still reduce the available lifetime allowance at age 75.
Testing DC pension benefits against the lifetime allowance

Age 75 has always been an important milestone in pensions.

Historically, you had to buy an annuity at age 75.

From 2006, you still had to fully crystallise all benefits at age 75, but you had a choice of annuity or income drawdown.

From 2011, the rules changed again, and you could leave your funds entirely uncrystallised if you wanted to.

Age 75 is also a key point for lifetime allowance (LTA) purposes, as for the vast majority of people this is the final time their pension funds will be tested against the LTA.

Given the 2011 changes, a client could conceivably have various different arrangements across their pension scheme(s) as they approach the age 75 test.

These could be uncrystallised arrangements, whether in a defined benefit (DB) scheme or a defined contribution (DC) scheme.

Or they could have arrangements representing pensions already in payment, whether through income drawdown, a lifetime annuity or a DB scheme pension. These may have come into payment pre-2006 or from 2006 onwards.

All of these arrangements are treated in different ways at age 75.

This article focuses primarily on the position for DC pension benefits at age 75, with occasional references to DB. 

Calculating the LTA usage at age 75

First of all, let’s look at which arrangements are tested and which are not.

The tables below split this out between DC and DB:

DC – tested at age 75DC – not tested at age 75
·         Uncrystallised funds (BCE 5B)·         Pre-2006 income drawdown in payment
·         Post-2006 income drawdown in payment (BCE 5A)·         Pre-2006 lifetime annuity purchased from DC funds
 ·         Post-2006 lifetime annuity purchased from DC funds
DB – tested at age 75DB – not tested at age 75
·         Uncrystallised funds (BCE 5)·         Pre-2006 scheme pension in payment
·         Post-2006 scheme pension in payment

Here’s how the calculations work for DC funds.

Uncrystallised funds (BCE 5B)

These are funds from which the client has not taken any benefits.

In terms of the calculation, the starting point is the value of the uncrystallised arrangement as at the client’s 75th birthday. As we are talking about a DC arrangement, this simply means the monetary value of the cash and assets held in that arrangement.

Calculation: Monetary value x 100 / standard LTA = LTA usage

Case study 1

Sally has an uncrystallised DC fund value of £500,000 at age 75. Her LTA usage would be calculated as follows: £500,000 x 100 / £1,030,000 = 48.54 per cent.

This is essentially the same calculation as the LTA test for a PCLS and designation to drawdown. Therefore, Sally is not disadvantaged in LTA terms by leaving her funds uncrystallised past 75.

Furthermore, any LTA used at age 75 is ignored when calculating available PCLS after the age of 75.

Post-2006 income drawdown in payment (BCE 5A)

When we talk about an income drawdown arrangement being in payment, it means that the funds have been allocated or designated to drawdown.

The client does not need to have actually received a payment for the arrangement to be considered in payment.

Here, the calculation is slightly more complicated:

(Value at age 75 – amount(s) initially designated) x 100 / standard LTA = LTA usage

To put a bit of context on this, we are effectively testing the growth in the fund value since the original designation to drawdown.