FOR ADVISERS ONLY
Lifetime allowance
- The lifetime allowance is the maximum value of benefits that can be taken from a registered pension scheme without being subject to the lifetime allowance charge.
- Benefits are only tested against the lifetime allowance when a benefit crystallisation events happens.
- It may be possible to protect benefits in excess of the lifetime allowance.
- The lifetime allowance is currently £1,073,100.
- The lifetime allowance charge applies if benefits exceed the lifetime allowance.
The lifetime allowance was introduced on 6 April 2006 (A-Day) but has not remained at the same level. It is currently £1,073,100.
Historic lifetime allowance levels can be found in our rates and factors area.
Benefit crystallisation events
Simply having benefits worth more than the lifetime allowance doesn’t trigger a lifetime allowance charge. Benefits are only tested against the lifetime allowance when a benefit crystallisation event happens. There are various benefit crystallisation events, most obviously when an individual takes benefits or dies. However there are also some automatic benefit crystallisation events at age 75 which test any uncrystallised benefits or any growth in drawdown funds.
A full list of the different types of benefit crystallisation events can be found in HMRC's Pensions Tax Manual.
Valuation of pension benefits
Defined Benefits
Defined benefit schemes can only offer a scheme pension. A scheme pension involves paying a pension for life out of the scheme assets or buying an annuity out of the scheme assets.
The value of the annual amount of pension promised by the scheme is multiplied by a standard valuation factor of 20:1. Where some of the pension is commuted for a lump sum, it is the pension after commutation that is multiplied by the standard valuation factor of 20:1. This factor includes an allowance for dependant's benefits up to the level of the member's pension at date of death and for annual increases of 5%. Any defined benefit scheme that provides better increases can apply to HM Revenue and Customs for a scheme specific valuation factor which can be higher than 20:1.
Defined benefit lump sums are valued using a factor of 1:1 and are added to the above value.
HMRC Pensions Tax Manual - PTM088620 - BCE 2 entitlement to a scheme pension
Money purchase (including cash balance) benefits
Drawdown - The valuation basis is based on the actual fund value (market value of the assets) used to secure either:
- income drawdown (whether capped* or flexi-access drawdown), or
- short-term annuities
* It's not been possible to set up a new capped drawdown plan since 6 April 2015.
Secured pension - The valuation basis used depends on the option chosen when benefits are crystallised. These are:
- Lifetime annuity - This is simply valued on the basis of the fund value used to secure the lifetime annuity.
- Scheme pension - Same as defined benefit schemes above.
If a scheme provides a separate tax-free cash lump sum and not by way of commutation this will be valued based on a valuation factor of 1:1 and added to the value above.
HMRC Pensions Tax Manual - PTM088640 - BCE 4 purchase of a lifetime annuity
Benefits that were in payment before 6 April 2006 also have to be included when valuing benefits taken after 6 April 2006. The benefits are valued when the first benefit crystallisation event takes place after 6 April 2006. Annuities in payment are valued at 25:1.
If the benefits are provided by capped income drawdown it is 80% of the GAD maximum income valued at 25:1.
If the capped drawdown plan is converted to flexi-access drawdown the valuation is 80% of the GAD maximum income for the year of conversion valued at 25:1.
The reason why they are valued at 25:1 rather than 20:1 is because the individual will most likely have taken a tax-free lump sum when the benefits were originally taken.
Lifetime allowance charge
The lifetime allowance charge applies to members who have benefits in excess of the lifetime allowance when benefits are taken. The lifetime allowance charge can apply in either of two ways or a combination of both depending on how the excess benefits are taken. The charge is:
- 25% on any income taken, and
- 55% if taken as a lump sum.
More information can be found in our article lifetime allowance charge.
Protection from the lifetime allowance charge
It is possible to apply for protection against the lifetime allowance.
Two forms of protection, fixed protection 2016 and individual protection 2016 were introduced on 6 April 2016. They were introduced when the lifetime allowance reduced to £1 million. Those intending to apply for fixed protection 2016 had to ensure that active membership of pension schemes ceased from 6 April 2016. There is no deadline for applying for fixed or individual protection 2016.
More information can be found in our articles fixed protection and individual protection.
Note
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.
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