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Lifetime allowance charge case studies

Published  27 January 2022
   8 min read

Anyone who has pension benefits with a value in excess of the lifetime allowance will be subject to a tax charge on their excess benefits value known as the lifetime allowance charge. These case studies show how this charge is applied.

In our Lifetime allowance charge article we had some basic examples showing how the charge is applied.

As life is rarely that simple, we have some more complicated case studies to help bring the subject to life.

The lifetime allowance charge can be applied in one of two ways or a combination of both depending on how the excess benefits value above the lifetime allowance is taken. The charge is:

  • 55% if taken as a lump sum, or
  • 25% if taken as income

Phased retirement

Emma was 57 on the 6 April 2010 and had a benefits value of £3 million. She takes her benefits in two stages - 6 April 2010 and 6 April 2023. She had not applied for any form of protection and had a tax-free cash entitlement of 25% of the benefits value.

On 6 April 2010 Emma decided to take £450,000 of her benefits value - 25% as tax-free cash with the balance used to provide an income. 

Benefits value at 1st crystallisation event. This image is an infographic and has alternative text available if you are using a screen reader.

Benefits value at 1st crystallisation event

Benefits value at 1st crystallisation event was £ 3,000,000
The lifetime allowance was £ 1,800,000
Amount of benefits was £ 450,000
The lifetime allowance charge applied was £ 0

Tax-free cash of £ 112,500 was paid
Being 25% of £ 450,000
The residual benefits used for income was £ 337,500 being £ 450,000 minus £ 112,500

Tax-free cash is the lesser of: 

  • 25% of the benefits value at crystallisation (£450,000 x 25% = £112,500), and
  • 25% of the lifetime allowance available at crystallisation (£1,800,000 x 25% = £450,000)

In this example Emma received a total lump sum of £112,500 with her remaining benefits value of £337,500 used to purchase an income. No lifetime allowance charge is payable at this time.

On the 6 April 2016 the lifetime allowance reduced from £1.25 million to £1 million. As she had not applied for primary or enhanced protection Emma decided to apply for fixed protection 2016. This lets her keep the £1.25 million lifetime allowance, although there are conditions that apply. Emma cannot:

  • Start a new arrangement except in permitted circumstances.
  • Have benefit accrual.
  • Make an impermissible or not permitted transfer such as:
    • A transfer to a scheme that is not a registered pension scheme or recognised overseas pension scheme.
    • A transfer of sums or assets from an arrangement under a registered pension scheme not relating to the individual.
    • A transfer of sums of assets which were held otherwise than by a pension scheme.

HMRC Pensions Tax Manual - PTM093400: Fixed protection - losing the protection

At the first crystallisation event, Emma used up £450,000 of her benefits value to provide retirement benefits. This was 25% of the lifetime allowance at the time (£1.8 million). The remaining lifetime allowance is used at the second benefit crystallisation event, before calculating the excess benefits value that any lifetime allowance charge would apply to.

This process is repeated each time benefits are taken until the whole benefits value are used up. Emma has fixed protection 2016 and a lifetime allowance of £1.25 million. When she takes her remaining benefits (including her excess benefits value as cash) on 6 April 2022, the lifetime allowance charge that will apply is as follows:

Benefits value at 2nd crystallisation event. This image is an infographic and has alternative text available if you are using a screen reader.

Benefits value at 2nd crystallisation event

Benefits value at the second crystallisation event was £2,650,000
The lifetime allowance was £1,250,000
Her remaining lifetime allowance remaining was £937,500 being 75% of £1,250,000 
Her excess benefits value was £1,712,500
The lifetime allowance charge was £941,875 being 55% of £1,712,500
Her net excess benefits value was £770,625
Her tax-free lump sum was £ 234,375 being 25% of her remaining lifetime allowance of £937,500
Her tax-free lump sum and her net excess benefits value of £770,625 gave her a total lump sum of £1,005,000
She also has residual benefits of £703,125 to provide an income, being £2,650,000 minus £941,875 and minus £1,005,000

Tax-free cash is the lesser of:

  • 25% of the benefits value at crystallisation = £2,650,000 x 25% = £662,500, and
  • 25% of the available portion of the lifetime allowance at crystallisation = (£1,250,000 x 75%) x 25% = £234,375

In this example Emma receives a total lump sum of £1,005,000 with her remaining benefits value of £703,125 being used to purchase an income. A lifetime allowance charge of £941,875 is paid.

If Emma hadn't applied for fixed protection 2016 and takes her remaining benefits (including her excess benefits value as cash) on the 6 April 2023 having already used up £450,000 of the lifetime allowance the lifetime allowance charge that will apply is as follows:

Benefits value at 2nd crystallisation event. This image is an infographic and has alternative text available if you are using a screen reader.

Benefits value at 2nd crystallisation event

Benefits value at the second crystallisation event was £2,650,000
The lifetime allowance was £1,073,100
Her remaining lifetime allowance was £804,825 being 75% of £1,073,100.
Her excess benefits value was £1,845,175
The lifetime allowance charge was £1,041,846 being 55% of £1,845,175.
Her net excess benefits value was £830,329
Her tax-free lump sum was £201,206 being 25% of her remaining lifetime allowance of £804,825.
Her tax-free lump sum and her net excess benefits value of £830,329 gave her a total lump sum of £1,031,535
She also has residual benefits of £603,619 to provide an income being  £2,650,000 minus £1,014,846 and minus £1,031,535

Tax-free cash is the lesser of:

  • 25% of the benefits value at crystallisation - £2,650,000 x 25% = £662,500, and
  • 25% of the available portion of the lifetime allowance at crystallisation - (£1,073,100 x 75%) x 25% = £201,206

In this example Emma receives a total lump sum of £1,031,535 with her remaining benefits value of £603,619 being used to purchase an income. A lifetime allowance charge of £1,014,846 is paid.  

Disclaimer

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.