Recent figures from HMRC show the impact of the lifetime allowance (LTA) is increasing rapidly and the government’s tax take has grown from a paltry £13m in 2006/07 to £185m in 2017/18.
The LTA affecting more people is not really a surprise. But the scale of the increase, along with the knowledge that many more clients will be affected over the next decade, highlights the need for careful tax planning.
The LTA was £1.5m when it was introduced in 2006, and grew to a peak of £1.8m.
From 2012 the government started to reduce the allowance and it fell as low as £1m, before edging up in line with inflation to the current level of £1.055m.
A test is carried out each time benefits are taken from a registered pension scheme to check if the LTA has been exceeded – these are known as Benefit Crystallisation events and there are 13 of them.
|BCE||What and when||Amount measured against LTA|
|1||Individual moves funds to provide a drawdown pension||The value of the amount moved into drawdown|
|2||Individual becomes entitled to a scheme pension before age 75||20 time the pension paid in the first year|
|3||An increase in a scheme pension exceeds a certain level||20 times the excess pension increase|
|4||Individual becomes entitled to a lifetime annuity||The value used to buy the annuity (less any amounts previously crystallised under BCE1 if funds are coming from a drawdown arrangement)|
|5||An individual reaches age 75 and has not taken all of their benefits under a defined benefit scheme||20 times the pension, plus any separate lump sum, as if these benefits were taken at age 75|
|5a||An individual with drawdown pension funds reaches age 75||The value of the drawdown less any amounts previously crystallised under BCE1|
|5b||An individual reaches age 75 with uncrystallised funds in a money purchase arrangement||The value of the uncrystallised funds|
|5c||An individual dies before age 75 and remaining uncrystallised funds are designated for dependant's or nominee's flexi-access drawdown||The value of the amount moved into drawdown|
|5d||An individual dies before age 75 and remaining uncrystallised funds are used to buy a dependant's or nominee's annuity *||The value used to buy the annuity|
|6||Payment of a relevant lump sum before age 75 (eg tax-free lump sum)||The amount of the lump sum|
|7||Payment of a lump sum death benefit where individual dies before age 75||The amount of the death benefit|
|8||Transfer to a Qualifying Recognised Overseas Pension Scheme (Qrops)||The amount transferred (less any amounts previously crystallised under BCE1 if funds are coming from a drawdown arrangement)|
|9||Any other event prescribed in regulations. Currently includes certain payments made (arrears after death, pension errors)||Depends on event|
*Needs to be within two years of Scheme Administrator being informed of death
If the value of benefits exceeds 100 per cent of the LTA, a lifetime allowance tax charge will be payable on the excess.
This is currently 55 per cent if the excess is taken as a lump sum.
If the excess remains in the pension wrapper, an immediate tax charge of 25 per cent is due and normal rules apply to any future pension withdrawals which are taxed as income.
The position is more complicated where people take benefits in different tax years when the LTA is different.
Each time a BCE occurs, some of the individual’s lifetime allowance is used up, leaving less lifetime allowance available for use in the future.
Each BCE is measured as a percentage of the LTA in that year.
When the LTA was introduced in 2006 the Government allowed people to apply for two types of protection – known as primary and enhanced protection – to enable people to protect their pension fund from the lifetime allowance charge.
Further types of protection have been introduced as the LTA was reduced in 2012, 2014 and 2016.
In essence, protection gives a member an entitlement to a special personal lifetime allowance and means a member will pay no, or a lower, lifetime allowance tax charge than if they used the standard LTA.
If an individual does not take their benefits until after age 75, then all uncrystallised funds are tested under BCE5b at age 75.
When the individual takes their pension benefits in future (eg at age 80) there is no further check against the lifetime allowance.
If a BCE occurs and the funds in question have already been the subject of an LTA check, the amount crystallised at outset are taken into account.
This concept prevents ‘double-counting’ and any growth is measured against the LTA on the second check.
Drawdown funds are subject to a further check at age 75 (BCE5a) which calculates the growth in the value of the benefits between entering drawdown and age 75.