Paul Squirrell: With the lifetime allowance, the devil’s in the detail

The lifetime allowance may have been introduced as part of 'pension simplification' back in April 2006 but given the constant tinkering it has seen since, writes Paul Squirrell, LTA planning can be far from simple

The lifetime allowance (LTA) may have been introduced as part of ‘pension simplification’ on 6 April 2006 – A-Day, as it was known – yet, given the constant tinkering it has seen over the years, LTA planning can be far from simple.

It was first introduced at a level of £1.5m and only affected a small proportion of the population. Since peaking at £1.8m though, for the tax years between 2010 and 2012, it has been reduced significantly. While it’s good news the LTA is now increasing in line with CPI, the current level of £1.055m is still someway short of the starting and peak allowances.

At 2.5% CPI, it would take approximately 15 years to return to the starting allowance and about 22 years to return to the previous peak. It is therefore easy to understand why significantly more individuals are being affected by the allowance.

From a planning perspective, these changes mean we not only have to forecast a client’s pension savings – and when and how they are likely to take benefits – but also what the allowance could be. This could involve planning up to the client’s 75th birthday.

It may not always be possible to avoid exceeding the LTA – however, by ensuring the individual has used any LTA protection or enhancements available and by considering how these excess benefits are taxed, we may be able to reduce the impact.

Available protections

It is easy to forget that two protections can still be applied for:

* Fixed Protection FP16: This is set at £1.25m and available if a client has not accrued pension benefits since April 2016. Fixed protection can be lost if the client enters into a new pension arrangement (including some death-in-service arrangements); and

* Individual Protection IP16: This is available if the client had pension savings valued at more than £1m as at 5 April 2016. The LTA will be the lower of the value of the savings as at that date or £1.25m.

Other than transitional protection, there are other situations where a lifetime allowance can be either enhanced or reduced, as outlined below.

The allowance can typically be enhanced in three scenarios, including where a client transfers a recognised overseas pension to the UK that has not benefitted from UK tax relief. An enhancement may also be made if a ‘disqualifying’ pension credit is received following divorce, for benefits where payment started after A-Day, as the benefits have already been tested against the ex-spouse or civil partner’s LTA.

Finally, a client may be able to apply for an enhancement where they have a UK-registered pension arrangement but accrue pension benefits while they are a non-UK resident. For employer contributions, the sponsoring employer would also need to be non-UK resident.

There are two examples meanwhile of where a lifetime allowance may be reduced. While any pension in payment prior to A-Day will never trigger a LTA charge, the value of any pensions in payment are tested at the first benefit crystallisation event (BCE) post A-Day, effectively reducing the available LTA.

In addition, any member with a protected retirement age of under 50 will have a reduced LTA if they take benefits before age 50 – it is reduced by 2.5% for each complete year between the date on which the BCE occurs and the date on which the individual will reach the age of 55.

Lifetime allowance tax charges

Where a client’s LTA has been fully used up, the tax charge on benefits crystallising above this amount will depend on the nature of the event. The LTA tax charge is often quoted as being set at 55%. Broadly speaking, however, there are normally only two BCEs that will trigger this tax rate.

First, this rate arises under BCE6, where the client is under the age of 75 and withdraws the excess funds as a lump sum payment. Second, under BCE7, where the client dies before the age of 75 with uncrystallised funds and a lump sum is paid out within two years.

This second example could be avoided by ensuring beneficiary drawdown is available. For all other BCEs, the LTA charge is normally 25%. Income tax may still apply to the withdrawals, depending on the nature of the event, and would be payable at the individual’s highest rate in the year the income is received.

Paul Squirrell is national pensions sales manager at FundsNetwork