[Estimated time to read: 5 minutes]
In 2008 the Lifetime Allowance on UK pension benefits was £1.8m. That figure today is £1.25m and as of the tax year 2016/17, it drops further to £1m. There is a clear trend and many people believe that it won’t be long until this figure becomes smaller still, possibly just £750,000.
The new 2016/2017 figure might still sound like a lot. However, over a 40 year career, this equates to £25,000 per year of pension savings or a little over £2,000 per month – not including any investment growth or increases in line with inflation.
If you have one or more UK pension schemes that are in the region of or above £1m in value, you could well be at risk of being taxed.
What is the Lifetime Allowance?
The Lifetime Allowance is a limit on the value of your pension schemes – as measured by ‘benefit crystallisation events’ such as lump sum payments or retirement income – that can be made without triggering an extra tax charge. It applies to the total of all the UK-registered pension schemes you have, including the value of pensions and lump sums promised through any defined benefit pension schemes you belong to, but excluding your State Pension.
I’m not sure if this applies to me, how can I find out?
The Lifetime Allowance calculation is applied to defined contribution or defined benefit schemes in the following ways:
For defined contribution (money purchase) schemes the value of your benefits will simply be the overall value of your pot, either in a single policy or across multiple ones, used to provide a retirement income and/or pension commencement lump sum. If this value is close to or above £1m then you will be affected.
For defined benefit (including final salary) schemes, you can calculate the approximate cash value by multiplying your expected annual pension by twenty (the factor used by HMRC). You also need to factor in any pension commencement lump sum that is paid in addition to income. As a broad guideline, you are likely to be affected by the Lifetime Allowance in the tax year 2015/16 if you are on track for a defined benefit pension (with no separate lump sum) of more than £62,500 a year or £46,875 a year plus the maximum pension commencement lump sum. These figures go down to £50,000 and £37,500 respectively as of April 6th 2016 for tax year 2016/17. The likelihood of course increases if you also have any defined contribution pension schemes.
I don’t like the sound of an extra tax charge! When is it applied?
As already mentioned, the Lifetime Allowance charge will only apply when a benefit crystallisation event (a “BCE”) occurs. BCEs take many forms, but the most common are taking benefits out of your pension or transferring your pension into a QROPS.
The way the charge is determined and how much it is depends on whether you receive the money from your pension as a lump sum or as part of regular retirement income.
Lump sums:
Any amount over your Lifetime Allowance that you take as a lump sum is taxed at 55%. Your pension scheme administrator or trustee will deduct this at source and pay the balance to you.
Income:
Any amount over your Lifetime Allowance that you take as a regular retirement income attracts a Lifetime Allowance charge of 25%. This is in addition to any tax payable on the income in the usual way.
If you wish to avoid the Lifetime Allowance charge it’s important to monitor the value of your pension schemes, and especially the value of changes (such as salary increases and ongoing years service) to any defined benefit pension schemes as these can be surprisingly large. Normally, the factor of 20 is applied to the defined pension amount coming into payment. However, for a transfer into a QROPS, it is the actual money value transferred. When actuaries calculate the value of a defined benefit pension for QROPS transfer purposes, part of the equation is related to gilt yields, annuity rates and a market value reduction factor based on ‘reasonable expected investment return’. The recent past has seen low gilt yields, low annuity rates and poor market conditions – all of which could mean your defined benefit pension scheme could be worth significantly more (on a transfer to a QROPS) than even a year ago.
I think I might be liable. Is there anything I can do?
The good news is there are a number of things that can be done to mitigate or avoid the Lifetime Allowance charge, if you haven’t already done so:
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Individual protection 2014 – if your pension was valued at £1.25m or more on 5th April 2014, you have until 5th April 2017 to apply for individual protection which will allow any amounts below £1.5m to remain unaffected by the Lifetime Allowance charge;
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Overseas Enhancement Allowance – if you spent time working outside the UK but still made accruals into a UK pension scheme, there is the potential to raise the Lifetime Allowance that applies to you by the amount built up during this period; and
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Transfer to a QROPS – if you are outside the UK and don’t intend to return, you can transfer your UK pension benefits into a QROPS. This means that the value of your pension scheme will be tested against the Lifetime Allowance at the time of transfer: once it’s outside the UK pension system it will no longer be subject to the Lifetime Allowance charge or other existing or potential UK tax rules, provided that you do not return to the UK.
This sounds quite complicated, what should I do?
UK pensions advice is a technical area, particularly when you have a defined benefit scheme or are above/approaching the Lifetime Allowance – especially if you are also no longer tax resident in the UK.
If you believe that breaching the Lifetime Allowance is a risk for you or are unsure about the impact it could have on your current or future arrangements you should speak to a specialist professional advisory firm to assess your options prior to taking any action.
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