Pension benefits held in a registered pension scheme will be tested against the lifetime allowance when:
There are a number of benefit crystallisation events (BCEs), each one triggers a test against the LTA. We’ll cover the more frequent BCEs that we receive queries on.
Every time someone takes benefits, the crystallised value is tested against the LTA. The crystallised value for a defined contribution (DC) scheme is the amount of the fund taken, for a defined benefit (DB) scheme it’s 20 x the pension taken plus the tax-free cash.
Take Karen, who took benefits with a value of £125,000 in 2015 when the LTA was £1.25m. The scheme administrator asks her if she has used up any LTA already and issues her with a statement stating that she’s used up 10% of the LTA with this crystallisation.
If she crystallises more funds, she’ll be able to tell the scheme administrator that she’s already used up 10% of the LTA. If her next crystallisation uses up another 20% of the LTA she’s now used up a total of 30% of the LTA and will have 70% left to apply to her next BCE. The 70% will be applied to the LTA prevailing at the time of that BCE.
If she crystallises an amount that’s more than the LTA she has left, the scheme administrator will ask her whether she wants to take the excess as a lump sum or used to provide income. Not all scheme administrators will offer both options.
If she chooses a lump sum, a charge of 55% of the amount over the available LTA will be deducted by the scheme administrator and paid to HMRC with the balance paid to Karen. This can be paid on top of the tax-free cash taken but remember that tax-free cash is restricted to the lower of 25% of the fund and 25% of the LTA that’s left.
If she chooses income, the charge will be 25% of the amount over the available LTA with the balance used to provide an annuity or a drawdown plan.
You can find more information and examples in our article lifetime allowance charge.
Some other BCEs happen automatically at age 75. These are:
The DB pension is valued at 20 x the full pension they would have received if they had taken benefits at age 75. The pension used is the pension before any commutation for tax-free cash. However if tax-free cash is provided separately (as is common in public sector schemes), that would be added in as a lump sum. The total amount is tested against the lifetime allowance available.
This BCE is triggered if there are still drawdown benefits to be paid out. The amount that is tested is the difference between the value of the fund at age 75 less the amount originally crystallised.
Obviously making withdrawals from the drawdown fund would result in a lower level of growth or no growth at all. However the withdrawals themselves will be liable for income tax, possibly at a 40% or even 45% rate.
The uncrystallised fund is then tested against the remaining lifetime allowance available.
Alan crystallised his £200,000 pension fund on 1 October 2007, taking £50,000 tax-free cash with the balance of £150,000 going into drawdown. This used up 12.5% of the 2007/08 lifetime allowance of £1,600,000. On 1 October 2017 (his 75th birthday), the drawdown fund is worth £220,000. The £70,000 growth in the fund is tested against £875,000, which is 87.5% of the lifetime allowance in 2017/18, so no lifetime allowance charge is due.
After age 75 the only BCE that can happen is where an annuity increases by more than a prescribed amount. This would be a rare occurrence, so for all practical purposes no BCE can happen after age 75.
Death is also a BCE so there’s no escaping an LTA test – an individual’s pension rights will be tested at some point. But an LTA charge will only apply if the BCE value is wholly or partly over the LTA available.
The information provided is based on our current understanding of the relevant legislation and regulations and may be subject to alteration as a result of changes in legislation or practice. Also it may not reflect the options available under a specific product which may not be as wide as legislations and regulations allow.
All references to taxation are based on our understanding of current taxation law and practice and may be affected by future changes in legislation and the individual circumstances of the investor.