The Lifetime Allowance (LA) is designed to limit the total pension savings an individual can accumulate tax-efficiently. Accumulated benefits in excess of the LA are taxed at rates which largely remove the tax benefits.
A LA test has to be undertaken every time there is a Benefit Crystallisation Event (BCE). The following information is intended to explain the process to be followed and details the different BCEs.
Benefit Crystallisation Events
Funds will be tested against the LA when one or more of the following thirteen Benefit Crystallisation Events, or (BCE) arise:
|1.||The designation of assets under a money purchase arrangement to provide a drawdown pension prior to age 75.|
|2.||Where a member becomes entitled to a scheme pension prior to age 75 under either a final salary or money purchase scheme.|
|3.||There is a discretionary increase to a scheme pension in payment which exceeds the ‘threshold annual rate’ and is also in excess of the conversion factor used to value the benefit against the LA (i.e. normally the higher of 5% pa or the RPI). This is determined on a cumulative basis since the member’s pension commenced.|
|4.||Where a member becomes entitled to a lifetime annuity under a money purchase arrangement prior to age 75.|
|5.||Where a member reaches age 75 with uncrystallised scheme pension and lump sum benefits from a defined benefit scheme.|
|5A.||Where a member has reached age 75 with benefits payable from a drawdown pension (where the benefits commenced on or after A-Day – 6th April 2006).|
|5B||Where a member has reached age 75 with uncrystallised benefits under a money purchase scheme.|
|5C||Where a member dies before age 75 and their remaining uncrystallised funds are designated for dependant’s or nominee’s flexi-access drawdown within two years of the scheme administrator being informed of the member’s death.|
|5D||Where a member dies before age 75 and their remaining uncrystallised funds are used to purchase (in whole or in part) a dependants’ or nominees’ annuity within two years of the scheme administrator being informed of the member’s death.|
|6.||Where the member becomes entitled to a relevant lump sum (i.e. a PCLS or standalone lump sum). Such a BCE in respect of a PCLS can normally only apply alongside a BCE 1, 2 or 4. From 6 April 2015 a BCE 6 will also apply to any uncrystallised funds pension lump sum|
|7.||A lump sum death benefit being paid in respect of the death of a member prior to age 75 from a defined benefit scheme or from the uncrystallised funds of a money purchase arrangement (other than a lump sum arising from crystallised benefits).|
|8.||A transfer to a ‘qualifying recognised overseas pension scheme’ (QROPS).|
|9.||Certain pension and PCLS payments that are treated as authorised member payments.|
Determining the Charge
Whenever benefits are taken, either on retirement or death of the member, it must be checked that the LA has not been exceeded. A check is also required at age 75 for members who have benefits that have not yet been taken (BCE 5 where these are benefits under a defined benefit scheme or BCE 5B where these are money purchase benefits). A test at age 75 is also required where a member is in receipt of capped or flexible drawdown benefits at that date (BCE 5A).
Where a member’s LA has been exceeded, the excess fund (referred to as the ‘chargeable amount’) where retained to pay pension benefits will be subject to a LA charge of 25% (55% where funds are drawn as a lump sum). Where this arises in respect of BCE 8 (i.e. a transfer to a qualifying recognised overseas pension scheme) this will be subject to a charge of 25%. The 55% rate cannot apply in this latter case, even though the payment in effect is a ‘lump sum’, because it is not being paid ‘to the individual’ and therefore does not fall within the 55% rate charging provision. The 25% rate also applies at age 75 when the LA is exceeded through BCE 5, 5A or 5B.
Where a ‘chargeable amount’ arises through BCE 6 (relevant lump sums i.e. a LA excess lump sum or a serious ill-health lump sum) or BCE 7 (a lump sum death benefit in respect of non crystallised benefits) the excess is taxable at 55%.
The scheme administrator and the member are jointly and severally liable to pay any tax due. The scheme administrator may meet the liability from scheme funds (i.e. a ‘scheme funded tax payment’) or by deducting it from the member’s benefits. In most cases it seems likely that the charge will be deducted from the member’s benefits, but where it is taken from scheme funds this will be treated as a further ‘chargeable amount’.
Where the scheme administrator reduces the member’s benefits to pay the LA charge, he/she can choose either to take the tax due out of any lump sum payable to the member or by reducing future pension payments. If the latter route is chosen, the amount by which the member’s pension benefits are to be reduced must be determined in accordance with normal actuarial practice.
The following examples will help to illustrate how the excess tax charge operates.
By the time Sarah decides to take her retirement benefits in 2017/18 tax year, she has accumulated a fund of £1.4 million, and the LA is £1 million. This means she has an excess fund of £400,000. Of that excess fund of £400,000, she decides to take £200,000 as a lump sum. Sarah has no transitional protection so the scheme deducts a 55% LA charge of £110,000 from her lump sum, paying her £90,000 net. Sarah has no more tax to pay on that lump sum.
Sarah uses the remaining £200,000 excess fund to provide a pension. The scheme deducts a 25% LA charge of £50,000, leaving a net fund of £150,000 which will provide pension income. Sarah must pay tax on her pension income at her marginal rate(s).
Alan took £1.5 million of his pension rights in June 2006, using up all of his Lifetime Allowance as he had no transitional protection. In August 2013 he decided to take further benefits from a personal pension scheme. He could have taken his benefit as a pension, but chose instead to take all of the £300,000 fund as a lump sum. The scheme deducted 55% from the lump sum (i.e. £165,000) paying Alan a net lump sum of £135,000. Alan has no more tax to pay on the residual lump sum.
It is important to note that the ‘chargeable amount’ is not income for income tax purposes. This means that an individual will not be able to set any allowances, losses or reliefs against the charge, and that the amount will not count as pension income, or any other income for the purposes of bilateral double taxation conventions.
It should be noted that a registered scheme is not obliged to offer its members the ability to take any excess benefits as a taxable lump sum.
How a scheme administrator establishes whether a member has sufficient available LA to cover the amount crystallising at a BCE is not prescribed by legislation. In some cases a scheme administrator may be prepared to rely on a simple member declaration, while in others it may be felt a more detailed questionnaire is necessary, with evidence requested.
Her Majesty’s Revenue and Customs’ (HMRC) Pension Tax Manual details one possible; though not mandatory, method in which the scheme administrator could ascertain whether a member’s crystallising benefits were within the LA limit.
This is as follows:
- Member indicates to scheme administrator he/she wishes to take a PCLS and lifetime annuity.
- Scheme administrator writes to member indicating how much will crystallise for LA purposes and the percentage of the then current standard LA it will utilise. The scheme administrator requests the member to provide a statement confirming the level of LA he/she anticipates being available at the expected BCE date and details of any other BCE he/she expects to occur under any other schemes on or before that date.
- The member will also be asked whether he/she is entitled to an enhanced LA and if so, to provide evidence of the certificate confirming the exact level of enhancement as issued by HMRC.
The member is given one month to provide the information.
Once the scheme administrator is satisfied that the benefits are within the member’s LA, they pay the benefits and provide the member with a statement for the amount of the standard LA utilised by that BCE.
If the investigations indicate the benefit crystallisation will result in the member exceeding his/her LA and a LA charge is to be made, the scheme administrator must provide the member with a notice giving details of:
- the chargeable amount in respect of the BCE,
- how the chargeable amount has been calculated and,
- the amount of the resulting charge to tax and to state whether he has accounted for the tax, or intends to do so.
In addition to the above information, the scheme administrator, may also wish to ascertain; prior to paying any benefit, whether the member has any pension which is already in payment and which commenced prior to 6 April 2006. This will be important because:
If this benefit crystallisation is the first in respect of the member after A-Day, the member’s LA at this BCE will be reduced to take account of the deemed value of the member’s pre A-Day pension (including drawdown) at the time of the BCE.
If this is not the first BCE since A-Day, account will still need to be taken of the reduction to the member’s available LA that occurred at the time of the first BCE post A-Day in respect of the pre A-Day pension in payment. This will not necessarily be reflected in the statement provided by the scheme where that first BCE occurred.
Other than to provide evidence (i.e. reference number of the certificate issued by HMRC) in support of an enhanced LA or transitional protection (enhanced protection, fixed protection etc), there are no specific provisions in the legislation requiring a scheme member to respond to any requests for information from the scheme administrator before a BCE.
A member can authorise HMRC to let a scheme administrator view their specified LA certificate(s).
If the member; or any other individual, makes a false statement or representation to the scheme administrator; whether prudently or negligently, that member/individual will become liable to a penalty of up to £3,000 if this results in relief from any LA charge being obtained (or any other tax due).
This six step Lump Sum Lifetime Allowance assessment process
Where a lump sum death benefit is payable (i.e. BCE 7) the following six step process should be followed in determining whether any LA charge is due and in HMRC assessing who is due to pay the charge:
- The scheme administrator tells the personal representatives of the deceased scheme member about the lump sum death benefit they have paid out. This must be done within 3 months of the final payment being made. Where the scheme administrator is unable to identify the deceased’s personal representatives within the time limit, a report addressed to the personal representatives (of the deceased) at the deceased’s last known address will fulfil the reporting requirement. The amount paid will be the full amount (i.e. there will be no deduction for any chargeable amount).
- The scheme administrator reports the lump sum death benefit to HMRC, where that payment (either alone, or in total with other such payments made under the scheme) comes to more than 50% of the standard LA for the tax year in which the member died. This report must be made by 31 January following the end of the tax year in which the lump sum death benefit was paid.
- The personal representatives calculate the deceased member’s available LA at the time of death, and whether a LA charge is due.
To do this, they should take account from the deceased’s records of any LA used up at earlier BCEs occurring in the deceased member’s lifetime. If they are aware of a prior BCE, but do not have details of the LA used up at that BCE, they can seek this information from the relevant scheme administrator (i.e. of any registered scheme of which the individual was a member) or insurance company (i.e. who has provided the individual with an annuity at any time during his lifetime) who are obliged to provide them with the certain information (see our Library Document on Scheme Administration).
- The personal representatives report any chargeable amount to HMRC within the required timescale (see Section 8 of our Library Document on Scheme Administration). If they are satisfied there is no chargeable amount no report is required to be sent to HMRC
- On receiving the report from the personal representatives, HMRC will find out details of the recipients of the lump sum death benefit from the scheme administrator(s) of the scheme(s) concerned. The scheme administrator has 2 months to provide the required information.
- HMRC will assess the recipient(s) of the lump sum death benefit in respect of any LA charge due. HMRC has 6 years from being notified of the lump sum death payment giving rise to the chargeable amount to make the assessment (i.e. 6 years from the point of notification by the personal representatives in point 4 above). However, an assessment cannot be made later than 20 years after the 31 January following the tax year in which the lump sum payment was made.
Once assessed, the recipient has 30 days from the issue of the notice of assessment to pay the due charge. Interest will accrue if the tax has not been accounted for by 31 January following the end of the tax year in which the lump sum death benefit was paid.
Who is Liable for the Lifetime Allowance Charge?
Where the LA charge applies in respect of a member’s vesting benefits, the scheme administrator and the member will be jointly liable to pay any tax due. Considering that the Finance Act 2004 obliges the scheme administrator to pay over the tax due to HMRC, the member has to inform HMRC of any liability under his/her self-assessment return and the normal self-assessment penalty and interest provisions will apply. In effect, the member has to declare on his self-assessment return any LA charge due together with the appropriate credit for tax paid by the scheme. Failure by the scheme administrator to pay the charge (or the correct level of the charge) does not absolve the member of liability for the charge. Where excess tax has been deducted, this will be repayable to the member.
Where a member’s benefits at a BCE exceed his lifetime allowance, the scheme administrator must give the member a notice that gives details of:
- the level of the excess arising at the particular BCE(s);
- how this figure has been calculated;
- the amount of the resulting LA charge, and
- whether the scheme administrator has accounted for the charge due, or intends to do so.
This information will enable the member to complete his self-assessment return.
This notice must be given to the member within 3 months of the BCE date and failure to do so will result in penalties being levied on the scheme administrator.
Where an excess fund applies on the death of the member, it will be the recipient(s) of the lump sum death benefit who will be responsible for paying the excess tax charge of 55%. Where there is more than one recipient, the liability will be apportioned between the recipients on what HMRC considers a just and reasonable basis.
The LA charge will apply regardless of whether any of the persons liable to it (or the scheme administrator where not liable) is resident, ordinarily resident or domiciled in the UK.
Discharge of Scheme Administrator’s Liability
As the scheme administrator is relying largely on declarations made by the member there will be circumstances where, based on the information to hand, the scheme administrator fails to reduce a member’s rights and payments at a BCE, when in fact a chargeable amount did crystallise at that BCE. Alternatively they may deduct an amount to cover a level of LA charge they ascertain as due, but not by an amount sufficient to cover the correct amount due.
This means that the scheme administrator may find themselves jointly liable for a charge but did not retain enough, or any, of the member’s funds/rights within the scheme to meet that liability (because, for example, all the monies were paid out to purchase an annuity).
Where this happens the scheme administrator can apply to HMRC to be discharged from their liability to the charge due by claiming that they acted in ‘good faith’ (i.e. where the scheme administrator reasonably believed that there was either no liability for a LA charge or that the amount of the charge deducted was the correct amount).
The good faith protection for the scheme administrator is aimed at the situation where they have been misled or been given incomplete information, by the member (or another party acting for them) leading them to assume wrongly that the member has more unused LA than they in fact have.
If the scheme administrator believed the member was going to deal with the liability himself, or that one of the other schemes in which the member had benefits was going to settle the liability, the liability will remain that of the scheme administrator until either the member, the scheme administrator or a combination of the two pays the tax due. These circumstances are not ones that the good faith provisions are intended to cover.
If HMRC consider that, in the circumstances of the case, it would not be just and reasonable for the scheme administrator to be liable for the charge due (or part of the charge due), they will discharge the scheme administrator of their liability. The member will then become solely liable to the charge (as the discharge of the scheme administrator’s liability does not alter the member’s own liability).
Refund of Overpaid Lifetime Allowance Charge
A scheme administrator will be able to claim a repayment from HMRC where an excessive amount of LA tax has been paid due to an error. In certain circumstances the scheme administrator will be able to use the repayment to pay benefits to a member as if the error had not been made. For example, in such a case it will be possible to pay a PCLS if more than 12 months have elapsed since the commencement of the individual’s pension. This is despite the normal ruling that a PCLS must be taken within twelve months of the commencement of a member’s retirement benefits from an arrangement. In this case the PCLS must be paid within twelve months of the receipt of the refund of the overpaid LA charge from HMRC.
Lifetime Allowance Charge – Protected Rights – now of historic interest only
The Department for Work and Pensions (DWP) confirmed that an individual with pension rights in excess of the LA would be unable to meet the LA charge from his protected rights fund. The DWP indicated that the Pension Schemes Act 1993 does not allow for protected rights to be used for the purposes of meeting a taxation charge. As such the entire LA charge needs to be met from the non-protected rights fund.
The above created problems where a member had already drawn benefits with a value equal to/greater than his Lifetime Allowance, and then crystallised protected rights benefits.
This is no longer an issue in respect of BCEs on or after 6 April 2012, as protected rights were abolished from that date.
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Important information: With investment, your capital is at risk. Tax benefits and allowances described in this document are based on current legislation and HM Revenue & Customs practice and depend on personal circumstances. You should not take, or refrain from taking, action based on the content and no part of this document should be relied upon or construed as any form of advice or personal recommendation.
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