Pensions and tax
The lifetime allowance
The Lifetime Allowance is a limit on the amount of pension benefit that can be drawn from pension schemes – whether lump sums or retirement income – and can be paid without triggering an extra tax charge.
The lifetime allowance
The lifetime allowance was introduced in 2006 at a level of £1.5 million. It then increased each year to 2010,when it reached a level of £1.8 million. Since 2010, there have been a number of pension reforms which have led to the lifetime allowance being reduced. Its current level in the 2016-17 tax year is £1m having been reduced from £1.25 million.
While most people aren’t affected by the lifetime allowance, you should take action if the value of your pension benefits is approaching, or above, the lifetime allowance. As pensions are normally a long term commitment, what might appear modest today could exceed the lifetime allowance by the time you want to take your benefits. It may be necessary to take your pension early or stop contributing to the scheme/plan, even though you have not retired, to avoid your benefits exceeding the lifetime allowance. The test for the lifetime allowance is done each time you access a pension benefit.
We have produced a Spotlight on the lifetime allowance and action that may be needed following the latest reduction to the lifetime allowance. You can read it here.
You can also find more information about how the lifetime allowance applies, and how it may affect you on – click here for details.
When you draw benefits
When you draw benefits or if you should die before taking any benefits, a benefit crystallisation event (BCE) takes place and the value of your benefits are tested against the lifetime allowance. If you have not taken all of your benefits by age 75, a lifetime allowance test will be carried out at this age, on your remaining benefits.
If you’re a member of a defined contribution pension scheme, the value of your benefits is the value of your pension pot in that scheme.
If you're a member of a defined benefit pension scheme, the value of your benefits is calculated as 20x the pension that you have accrued under the scheme plus any tax free cash that you received (if you have been drawing income since before 6 April 2006, this income payment is valued by multiplying by a factor of 25).
If the value of all of your pension benefits, across all schemes, exceeds the lifetime allowance, any excess attracts a tax charge of 25% if it is withdrawn as an income (for instance from an annuity or a drawdown arrangement) or 55% if it is withdrawn as a cash lump sum.
You only face a tax charge if the value of your benefits exceeds the lifetime allowance when a BCE occurs.
The lifetime allowance and protection
When the lifetime allowance was introduced in 2006 and in subsequent years when it has been reduced, following pension reforms, those with benefits valued in excess of the lifetime allowance have been able to apply for ‘protection’ to protect the value of benefits they have built up (and future benefits that may accrue) from tax charges.
These protections include
- primary protection;
- enhanced protection;
- fixed protection and;
- individual protection
Each have different conditions attach to them.
You can find out more on the different protections on HMRC’s website here.
Where can I find out more?
If you need more information, please contact us. A pension specialist from our team will be happy to help with whatever pensions-related question you have. Our help is always free.