What is the lifetime allowance?
Pension simplification came into effect from 6th April 2006 to rationalise the British tax system regarding pension schemes. One of the policies introduced was the lifetime allowance for all UK pensions. The lifetime allowance is the limit on the number of pension benefits that can be taken without incurring a tax charge. As you can see in the chart below, the lifetime allowance, better known as LTA, was introduced in 2006 with a limit of £1.5m. The limit increased to £1.8m between 2006 – 2010 before decreasing and increasing between 2012 – today.
The LTA is currently set at £1,073,100 for the 2020/2021 tax year and would remain at its current level until 2025/26.
Does the lifetime allowance affect me?
Whenever benefits are taken from a personal or workplace pension, you use up a percentage of the Lifetime Allowance. This is known as a Benefit Crystallisation Event (BCE). A BCE arises in the following circumstances:
- Entering drawdown (BCE1)
- Entering scheme pension (BCE2)
- Scheme pension in payment increasing beyond a permitted margin (BCE3)
- Buying a lifetime annuity (BCE4)
- Reaching age 75 before taking all benefits from a defined benefit pension (BCE5)
- Reaching age 75 with a drawdown fund (BCE5A)
- Reaching age 75 before taking all benefits from a defined contribution pension (BCE5B)
- Funds on death under age 75 being used to provide drawdown for dependant/nominee (BCE5C)
- Funds on death under age 75 being used to buy an annuity for dependant/nominee (BCE5D)
- Taking relevant lump sums (including Pension Commencement Lump Sums (PCLS) and
- Uncrystallised Funds Pension Lump Sums (UFPLS)) (BCE6)
- Fund on death under age 75 being paid as a lump sum (BCE7)
- Transferring to a Qualifying Recognised Overseas Pension Scheme (QROPS) (BCE8)
- Various one-off payments as prescribed in regulations (BCE9)
A BCE can be a useful form of tax planning for pension members that have an LTA liability. Understanding what each BCE means and how it applies to you is important to make a rational decision regarding how to access your pension tax efficiently. Our advisers are experienced in this area and can help you plan effectively to minimise the tax liability as much as possible.
What tax will I pay above the LTA?
The amount of tax you pay on pension savings above the LTA depends on how the money is paid to you. The two tax charges are as follows:
- 55% if you tax a lump sum
- 25% if you withdraw the money as income
Based on the two applicable tax rates, it´s common sense that you would want to avoid 55% tax at all costs. This is only possible in certain arrangements such as a SIPP, as it allows you to access “flexi-access drawdown”. This withdrawal option is not available in a defined benefit scheme or should you purchase an annuity or access drawdown through a DC scheme.
For example: if your SIPP is valued at £1.45m and you don´t have protection. The current LTA is £1,073,100; therefore you have an LTA liability of £376,900. The prudent approach would be to only “crystalise £1,073,100 of your SIPP and leave the remaining £376,900 uncrystallised. This would enable you to take the 25% PCLS on the crystalised pot and begin accessing drawdown without incurring any LTA tax charges. Upon accessing the “uncrystallised pot” (assuming we are doing this on the same date for illustration purposes), you would then “waive your right to your 25% PCLS” which means you wouldn’t get 25% of the pot size tax-free. Instead, you would be able to withdraw the pension as income only and would only have to pay a 25% LTA tax charge, instead of 55%. This tax liability would be GBP 94,225.
Can I protect myself against the LTA?
There are several protectors that you could have applied for that protects you against any drop in the LTA such as enhanced and primary protection, which is no longer available or fixed protection and individual protection. You can still apply for Individual protection 2016 and fixed protection 2016 if you meet certain requirements. To find out more info, please visit the HMRC website link below:
https://www.gov.uk/guidance/pension-schemes-protect-your-lifetime-allowance
There are also technical ways to reduce this LTA charge over your lifetime that require a serious amount of planning.
What other ways can I protect against the LTA?
A QROPS (Qualified recognised overseas pension scheme) provides many benefits to someone residing or looking to reside overseas. One of the benefits is that it has no lifetime allowance and is only tested once upon transfer. The LTA tax charge upon transfer to a QROPS is a flat 25% regardless of how you access your benefits. This approach is much simpler but of course, only available for European residents as transfers to a QROPS outside of Europe would incur an “overseas transfer charge” of 25%. This charge would also apply if you moved outside of Europe within 5 years of the transfer.
Inflation-linked LTA
There have been changes that have come into effect that now increases the lifetime allowance by the UK inflation rate each year, however, this has been frozen until 2025/26. There have been additional talks that have indicated the LTA could drop to as little as £800,000!
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