Lifetime allowance charge - case studies

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 either 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 2021 and 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 £500,000 of her benefits value - 25% as tax-free cash with the balance used to provide an income. The lifetime allowance charge that would apply on her excess benefits value would be as follows: 

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Tax-free cash is the lesser of: 

• 25% of the benefits value at crystallisation (£500,000 x 25% = £125,000), and
• 25% of the lifetime allowance at crystallisation (£1,800,000 x 25% = £450,000)

In this example Emma received a total lump sum of £125,000 with her remaining benefits value of £375,000 being 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:

• Accrue more benefits in any pension plan, for example pay more contributions to a money purchase plan or accrue more benefits under a defined benefit arrangement.
• Start a new plan unless it is set up to accept a transfer value.
• Transfer benefits anywhere other than to a registered pension scheme or to a qualifying recognised overseas pension scheme.
• Transfer benefits from a money purchase scheme to a cash balance or defined benefit scheme.

At the 1st crystallisation event Emma used up £500,000 of her benefits value to provide retirement benefits. This was 27.78% of the lifetime allowance at the time (£1.8 million). The remaining 72.22% is applied to the lifetime allowance in force at the 2nd 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 is used up. So, as Emma has fixed protection 2016 and takes her remaining benefits (including her excess benefits value as cash) on the 6 April 2021 having already used up £500,000 of the lifetime allowance, the lifetime allowance charge that will apply is as follows:

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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 72.22%) x 25% = £225,687.50]

In this example Emma receives a total lump sum of £1,011,950 with her remaining benefits value of £677,062.50 being used to purchase an income. A lifetime allowance charge of £960,987.50 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 2021 having already used up £500,000 of the lifetime allowance the lifetime allowance charge that will apply is as follows:

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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 72.22%) x 25% = £193,748.21]

In this example Emma receives a total lump sum of £1,037,501.44 with her remaining benefits value of £581,244.61 being used to purchase an income. A lifetime allowance charge of £1,031,253.95 is paid.  

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.