Lifetime allowance all you need to know

When does it apply?

A test against the lifetime allowance is done when there’s a benefit crystallisation event. There are several benefit crystallisation events (opens in new window), the most common of which are:

• Taking benefits.
• Dying.
• Transferring to a QROPS.
• Reaching age 75.

A lifetime allowance charge can only apply when the value of an individual's pension savings at a benefit crystallisation event is over the lifetime allowance. So, if they have pension savings of £2,000,000, there’s no charge at that point. But if they crystallise all of their pension savings, there will be a lifetime allowance charge on the excess of £926,900 (£2,000,000 - £1,073,100).

The crystallised value for a defined contribution scheme is the amount of the fund taken. For a defined benefit scheme, it’s 20 x the pension taken plus the tax-free cash.

Is there a charge?

If an individual crystallises benefits above the lifetime allowance, there’s a lifetime allowance charge.  It can therefore be seen as a tax on pension savings growth; growth resulting from contributions and growth on investment returns.

How much is the charge?

It depends on how the individual takes their benefits. Any excess over the lifetime allowance can be taken as a lump sum (a lifetime allowance excess lump sum) and the charge is 55%.

Alternatively, the excess can be used to provide an income, by either a pension annuity or income drawdown. The charge is then 25% but any pension instalments or withdrawals made are taxed at the individual’s marginal rate of income tax. If the individual pays income tax at 40%, the tax ‘take’ is similar to taking the benefits as a lump sum. If the individual pays income tax at 20% the tax take is less.

When an individual takes benefits or reaches age 75, both the individual and the scheme administrator are jointly liable for paying the charge. Normally the scheme administrator deducts the charge from the pension fund and pay it to HMRC.

How does it work?

Not everyone takes all their benefits at the same time. An individual could have several pension plans and crystallise them at different times or a defined contribution plan could be crystallised in stages.

Each benefit crystallisation event uses up a proportion of the lifetime allowance that applies at the time.

Every time an individual crystallises pension savings, they’re asked by the scheme administrator what percentage of the lifetime allowance they’ve already used up.

The scheme administrator then calculates how much of the lifetime allowance this crystallisation has used up and issues a lifetime allowance statement to the individual. If the crystallisation uses up more than the remaining lifetime allowance, the scheme administrator will ask the individual if they want to take the excess as a lump sum or pension and deduct the appropriate charge.  

See our article Benefit crystallisation events and the lifetime allowance charge for examples.

On the lifetime allowance statement the percentage used up is always based on the lifetime allowance in the tax year the benefit crystallisation event happens, and the balance left is always applied to the lifetime allowance at the next benefit crystallisation event.

So, if someone crystallised £100,000 in 2017/18 when the lifetime allowance was £1 million, they’ll have used up 10% of the lifetime allowance.  If they crystallise more pension savings now, they can crystallise up to 90% of £1,073,100 = £965,790 before a lifetime allowance charge applies. 

Equally, once they’ve used up all of the lifetime allowance, all further benefit crystallisation events are chargeable – there’s no further lifetime allowance available even if the lifetime allowance increases.

What happens when an individual dies?

If they die before age 75 this is a benefit crystallisation event, or to be accurate, is one of several benefit crystallisation events depending on the way the benefits are taken.  

Benefit crystallisation event 7 (opens in new window) - the beneficiary takes a lump sum death benefit.

Benefit crystallisation event 5C (opens in new window) - the beneficiary takes a beneficiary drawdown.

Benefit crystallisation event 5D (opens in new window) - the beneficiary takes a dependant’s or nominee’s annuity.

Where beneficiary drawdown is available and a lifetime allowance charge is due, it doesn’t make any sense for the excess over the lifetime allowance to be taken as a lump sum if the deceased is under age 75. This is because it will attract a lifetime allowance charge of 55% on the excess.

If the death benefit is taken as beneficiary drawdown, the charge will be only 25%, saving 30%, and the entire drawdown fund can be taken at any time. Of course, if death had been after age 75, the withdrawals attract an income tax liability at the beneficiary’s marginal rate.

The liability for paying any lifetime allowance charge falls on the recipient, not the scheme administrator. The charge is calculated by the Executor of the Estate as only they will know what other untested benefits the deceased had.

HMRC Pensions tax manual - PTM088500 - The lifetime allowance and the lifetime allowance charge: benefit crystallisation events: summary of the process for testing BCEs against the lifetime allowance when the member has died.

What happens if UK pension savings are transferred overseas?

A transfer overseas can only be to a Qualifying Recognised Overseas Pension Scheme (QROPS) otherwise it’s an unauthorised payment.

Unlike a recognised transfer between two UK registered pension schemes, a transfer from a UK scheme to a QROPS is a benefit crystallisation event (benefit crystallisation event 8 - opens in new window). So, if the amount of the transfer is over the relevant lifetime allowance, a lifetime allowance charge will apply.

However, because the payment is not to the individual, the rate charged is 25%, not 55%, despite the fact that it involves a lump sum. If the pension savings were in respect of a pension drawdown plan which started before 6 April 2006 there will be no benefit crystallisation event 8 on transfer.

If pension savings were designated as drawdown from 6 April 2006, they will have been tested against the lifetime allowance (benefit crystallisation event 1) or scheme pension (benefit crystallisation event 2).

To prevent double counting the overlap provision apply. The benefit crystallisation event 1 or benefit crystallisation event 2 amount is deducted from the value being transferred as a benefit crystallisation event 8. The difference is tested against the individual's remaining lifetime allowance and any excess has a 25% charge deducted.

What happens at age 75?

A more or less final check against the lifetime allowance is made at age 75. ‘More or less’ because the only benefit crystallisation event that’s possible after age 75 is a benefit crystallisation event 3.This is when a scheme pension from an occupational pension scheme is increased by more than a permitted margin. This is very unusual.

What’s tested at age 75?

• Any uncrystallised DB pension savings – benefit crystallisation event 5
• Any growth in a drawdown plan since it was set up – benefit crystallisation event 5A
• Any uncrystallised DC pension savings– benefit crystallisation event 5B.

There are no further benefit crystallisation events if an individual crystallises pension rights or dies after age 75.

Can an individual get tax-free cash after age 75?

Yes, if the terms and conditions of plan holding the benefits allow. The maximum that can be taken is the lower of 25% of the fund and 25% of the available lifetime allowance, unless they have some form of tax-free cash protection, more details are below.

You might expect the amount of the lifetime allowance available to be reduced by any benefit crystallisation events at age 75, but for this purpose, the benefit crystallisation event at age 75 that test uncrystallised benefits are ignored. The lifetime allowance used in the maximum tax-free cash calculation isn’t reduced by any age 75 benefit crystallisation events.  

See our article Lifetime allowance at age 75 for more details.

Are there any ways to protect against a lifetime allowance charge?

There are several forms of protection, each of which became available at different points in the history of the lifetime allowance.

When pensions simplification was introduced on 6 April 2006 two types of protection were available:

Primary protection was available if the value of an individual’s pension savings exceeded the original lifetime allowance of £1.5 million on 6 April 2006. An increase factor was applied to the standard lifetime allowance based on the amount of the excess over the lifetime allowance.

So if an individual’s pension savings were worth £3 million on 6 April 2006, they were given a primary protection factor of 1, meaning their personal allowance is twice the standard lifetime allowance. This factor is based on a standard lifetime allowance of £1.8 million (the highest the lifetime allowance reached) until such time as the standard lifetime allowance exceeds £1.8 million.  If an individual had a primary protection factor of 1, their lifetime allowance would be £3.6 million.

Tax-free cash can also have primary protection if the tax-free cash on 6 April 2006 was greater than 25% of the fund and greater than £375,000. The protected tax-free cash increased in line with increases in the lifetime allowance. The lifetime allowance reached a peak of £1.8 million on 6 April 2011 and decreases since then are ignored.

So tax-free cash of 120% (1.8/1.5) of the tax-free cash value on 6 April 2006 can be paid until such time as the standard lifetime allowance exceeds £1.8 million. After that it increases in line with lifetime allowance increases. If tax-free cash was less than £375,000 on 6 April 2006, the amount payable is the lower of 25% of the fund and 25% of £1.5 million.

Enhanced protection could be given to pension savings of any size on 6 April 2006 although clearly it will only be useful if the pension savings were likely to exceed the lifetime allowance in the future. With enhanced protection, the pension savings can grow to any size but there can be no contributions paid to defined contribution schemes and no relevant benefit accrual (opens in new window) in defined benefit schemes post 6 April 2006.

If tax-free cash on 6 April 2006 was greater than £375,000 and greater than 25% of the fund, enhanced protection of the tax-free cash will allow the same percentage of tax-free cash to apply post 6 April 2006. If tax-free cash was less than £375,000, enhanced protection doesn’t apply to the tax-free cash; the amount available will be the lower of 25% of the fund and 25% of £1.5 million.

Scheme specific tax-free cash protection may also apply.

Both primary and enhanced protection had to be applied for before 6 April 2009.

Fixed protection. The lifetime allowance was steadily reduced from its high point of £1.8 million in 2010/11. It is currently £1,073,100.

Each time it was reduced, fixed protection was made available to allow the individual to retain the previous lifetime allowance.  However, any contributions or benefit accrual results in the loss of fixed protection. Some transfers also result in the loss of fixed protection.

• Fixed protection 2012 gives a lifetime allowance protection of £1.8 million
• Fixed protection 2014 gives a lifetime allowance protection of £1.5 million
• Fixed protection 2016 gives a lifetime allowance protection of £1.25 million

Fixed protection 2016 is the only one that can still be applied for.

Benefit accrual under fixed protection is different from the relevant benefit accrual that applies to enhanced protection. Fixed protection can be lost in any tax year where there’s been any benefit accrual.

Enhanced protection is only lost at the time of taking benefits or transferring from a defined benefit scheme to a defined contribution scheme – the calculation (opens in new window) to see if relevant benefit accrual has happened is done at that point.

Individual protection allows a protected lifetime allowance up to the capped value of total pension savings at a certain date.

Individual protection 2014 provides protection up to the lower of the value of total pension savings on 5 April 2014 and £1.5 million.  A minimum benefits value of £1.25 million on 5 April 2014 was required.

Individual protection 2016 provides protection equal to the lower of the value of total pension savings on 5 April 2016 and £1.25 million. A minimum benefits value of £1 million on 5 April 2016 is required.

Further contributions, benefit accrual or transfers don’t result in the loss of individual protection 2014 or individual protection 2016.

It is still possible to apply for fixed protection 2016 and individual protection 2016; there’s no time limit for applications.

An individual can even apply retrospectively after a benefit crystallisation event.  In that event, the scheme administrator will have to recalculate the amount of lifetime allowance used up by the benefit crystallisation event and re-issue the lifetime allowance statement.  If any charge had been paid, they’ll also apply to HMRC for a refund of some or all of the charge.