Advisers need a detailed knowledge of the lifetime allowance test in order to confirm if clients will face a charge
There is no limit on the total amount of authorised benefits a registered pension scheme can provide to its members. However, an individual has a single lifetime allowance in relation to the value of tax-privileged benefits they can draw from such schemes.
When a benefit crystallisation event occurs, a lifetime allowance test is carried out.
There are 13 ways a BCE could occur, the majority of which coincide with benefit payments made before age 75.
The test itself involves the amount crystallised being calculated and tested against the individual’s lifetime allowance headroom. The responsibility for carrying out the test sits with the scheme administrator or, where a BCE occurs on death, the deceased’s personal representative.
Where the amount crystallised under the BCE exceeds the individual’s lifetime allowance headroom, the individual will be subject to a lifetime allowance charge unless they enjoy enhanced protection.
There are a number of factors that affect the headroom:
- Protected pension age. Establishing the individual’s lifetime allowance should always be the starting point in determining the headroom they have when a BCE occurs. The standard lifetime allowance in the current tax year of 2018/19 is £1.03m, unless an individual enjoys some form of lifetime allowance protection, benefits from a lifetime allowance enhancement factor, or both. Where a member has an unqualified right to take benefits earlier than normal minimum pension age (currently 55), the earliest age at which benefits may be taken is known as the member’s protected pension age. In cases where a member has a protected pension age of less than 50 and takes benefits before 55, their lifetime allowance is reduced by the “relevant percentage” (2.5 per cent for each complete year between the benefit crystallisation event and normal minimum pension age).
- Previous BCE. Each time a BCE occurs more lifetime allowance is used up.
- Benefits in payment pre-6 April 2006. At a BCE, any pensions in payment that commenced prior to 6 April 2006 account for part of the individual’s lifetime allowance. The amount of the individual’s lifetime allowance used up is quantified at the first BCE and is 25 x annual rate of pension in payment at this BCE. Identifying the annual rate of pension in payment at the first BCE is relatively straightforward where the pension in payment is either an annuity or scheme pension. However, where the pension in payment is in drawdown it can be a touch more complicated. The following illustrates how some of these factors interact.
Andrew has fixed protection 2012. He is in receipt of pension from a final salary scheme that commenced prior to 6 April 2006.
In the 2012/13 tax year he part crystallised his Sipp to the value of £600,000. This was his first BCE and the annual rate of pension payable from the final salary scheme at that point was £22,800.
The amount of lifetime allowance used up following the first BCE was:
- Scheme pension in payment = £22,800 x 25 = £570,000.
- Sipp (PCLS and drawdown) = £600,000.
The total of £1.17m was less than Andrew’s lifetime allowance of £1.8m.
Andrew made a successful application for individual protection 2014, as the value of his benefits as at 5 April 2014 totalled £1.4m. This form of protection was dormant.
Andrew made a contribution to his Sipp in March 2018. So, from that date he lost fixed protection 2012 and the dormant individual protection 2014 became active.
His lifetime allowance is now £1.4m and the headroom for any BCE occurring in 2018/19 would be calculated as follows:
- Lifetime allowance used up by scheme pension in payment and 2012/13 BCE: £1.17m/£1.8m = 65 per cent
- BCE 2018/19: Lifetime allowance headroom = 35 per cent of £1.4m = £490,000
A lifetime allowance charge reduces the funds available and allowing for any reduction is a crucial part of the retirement planning process. Identifying any lifetime allowance charge requires detailed knowledge of the lifetime allowance test; part of which involves calculating the lifetime allowance the individual has available at a BCE.
It is true the responsibility for carrying out the test does not lie with advisers. However, if they are to add value to their clients’ retirement planning, knowledge of the mechanisms of the test is essential, as well as providing a check on the work carried out by scheme administrators and personal representatives.
Neil MacGillivray is head of technical support at James Hay