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Lifetime Allowance (LTA): Q&A

Author Image The Technical Team
15 minutes read
Last updated on 17th Apr 2018

Overview

Questions from advisers answered on the lifetime allowance, including queries about protection, LTA excesses, pre A-day benefits, LTA on death and other general questions.

Lifetime Allowance increasing by CPI

Q. My client crystallised benefits of £1m when the Standard LTA was £1m. Now that the Standard LTA has increased by CPI to £1.03m can they crystallise further benefits without incurring a LTA excess?

A. If your client crystallised £1m of benefits when the Standard LTA was £1m this will have used up 100% of their LTA. Therefore, as they have no LTA remaining they will not benefit from the CPI increase and any further benefits they crystallise will be subject to a LTA excess tax charge.

Q. My client has Fixed Protection/Individual Protection, will their protected LTA amount increase by CPI from 2018 onwards?

A. No, the increase by CPI from 6 April 2018 onwards only applies to the Standard LTA. Where someone holds protection, their protected LTA amount will not increase, however, if at any point the Standard LTA increases to an amount that is greater than an individual’s protected amount they will then revert to the higher standard LTA amount. For example, someone with IP16 and a protected LTA of £1,025,000 will get the standard LTA of £1,030,000 from 6 April 2018.

Lifetime Allowance & Tax Free Cash

Q. My client has 10% of the Standard LTA (£1.03m) remaining and now wants to transfer their personal pension pot of £200,000 to drawdown, can they get their full (25%) tax free cash entitlement of £50,000?

A. No, they are only entitled to tax free cash on benefits crystallised up to their available LTA, which is 10% of £1.03m = £103,000, so can get TFC of 25% = £25,750. The additional £97,000 will be a LTA excess and can be taken as a lump sum after a 55% tax charge or used to provide income (from drawdown or an annuity) after a 25% tax charge.

Pre A-day Benefits

Q. How are pre A-day pensions in payment tested for LTA purposes?

A. Pensions that were put into payment prior to 6 April 2006 (also known as pre-commencement pensions) are treated as having crystallised immediately prior to the client’s first post A-day BCE and effectively reduce the amount of LTA available.  The value used depends on what type of pension the pre A-day pension is: 

  • Scheme pension = 25 x annual pension amount at the date of the first post A-day BCE

  • Capped Drawdown (where the first post A-day BCE is between 06/04/06 and 05/04/15) = 25 x Capped Drawdown Limit at date of BCE 

  • Capped Drawdown (where the first post A-day BCE is after 05/04/15) = 80% x 25 x Capped Drawdown Limit at date of BCE

  • Flexi-access Drawdown = 80% x 25 x last available capped drawdown limit (i.e. just before the plan converted to flexi-access)

So, if a client with no LTA protection and a pre A-day capped drawdown plan with a capped drawdown limit of £15,000 had a BCE on 1 May 2017, the pre A-day drawdown would use up:

80% x 25 x £15,000 = £300,000/£1,000,000 = 30% of their LTA meaning they had £700,000 available for the post A-day BCE.

Where the pre A-day benefits use up more than the client’s LTA no charge arises on the excess for the pre A-day benefits, however the full amount crystallising at the post A-day BCE will be a LTA excess, e.g:

Client has no LTA protection and a pre A-day pension in payment of £75,000 on 1 June 2017 when they decide to crystallise further benefits of £150,000. The pre A-day pension uses up 25 x £75,000 = £1,875,000 so the client has no LTA remaining, can take no further TFC and the full £150,000 is a LTA excess. However there is no charge on the £875,000 that was over the available LTA when the pre A-day benefits were tested.

Lifetime Allowance & Defined Benefit Schemes

Q. My client has no LTA protection and is about to do a transfer from a defined benefit scheme, which has a value of £1.4 million, to a money purchase arrangement. Will the LTA excess tax charge be deducted when the fund is transferred?

A. Not unless the funds are being immediately crystallised. If the client is transferring the funds and leaving them uncrystallised this is not a BCE and there is no test against the client’s LTA and therefore no LTA excess will occur. 

If the funds are being fully crystallised the client can take benefits up to their available LTA of £1.03m (e.g. £257,500 TFC and designate £772,500 to drawdown). The additional £370,000 will be a LTA excess and can either be taken as a LTA excess lump sum, after a 55% tax charge has been deducted, or used to provide income from drawdown or an annuity, after a 25% tax charge has been deducted. In either case the scheme administrator will deduct the tax charge up front and account for this to HMRC on the client’s behalf.

Q. My client is about to take benefits from his defined benefit scheme. How will commuting some of his pension for a PCLS impact the LTA used?

A. This depends on the commutation factor used by the scheme and can mean less LTA is used if the maximum PCLS is taken, e.g. Client has been offered a pension of £18,644 or a reduced pension of £13,293.84 with a PCLS of £64,201.92 based on the scheme’s commutation factor of 12:1. They have no LTA protection.

Taking the full pension option would use up:

20 x £18,644 = £372,880/£1,030,000 x 100% = 36.20%

Taking the maximum PCLS and reduced pension would use up:

20 x £13,293.84 + £64,201.92 = £330,078.72/£1,030,000 x 100% = 32.04%

Q. My client has benefits in a defined benefit scheme and is being offered a CETV of £1.3million. They have accrued benefits in the scheme after 5 April 2016 and as at 5 April 2016 their pension benefits were valued at 20 x the pension available at that time which was £45,000 = £900,000. What options do they have as far as LTA protection is concerned?

A. The only two forms of LTA protection currently available are Fixed and Individual Protection 2016. However, as your client has had benefit accrual after 5 April 2016 they are not eligible for FP16 and as the value of their benefits didn’t exceed £1million on 5 April 2016 they are not eligible for IP16.

Q.  How is a dependant’s scheme pension treated for LTA purposes?

A.  An arising entitlement to a dependant’s scheme pension is not a benefit crystallisation event and is therefore not tested against the deceased member or the dependant’s lifetime allowance. A dependant’s scheme pension is also always subject to income tax regardless of whether the member dies before or after age 75.

Q.  My client has Fixed Protection 2014 and is considering transferring benefits from a defined benefit scheme to a money purchase arrangement, will this result in the loss of FP14?

A.  As long as the transfer is a ‘permitted transfer’ this will not cause FP14 to be lost. For the transfer to be classed as a permitted transfer, the value of the sums and assets received by the money purchase arrangement must be actuarially equivalent to the rights being transferred. Therefore provided the scheme is not offering an enhanced transfer value, i.e. an additional incentive on top of the normal transfer value calculated by the scheme actuary FP14 will not be lost. 

Lifetime Allowance & Protection

Q.  What protections are currently available and what are the eligibility criteria? 

A. The LTA protections which are currently available and the eligibility criteria are as follows: 

Individual protection 2016 – a client needs to have benefits valued in excess of £1m on 5/4/16 to apply and there is currently no end date for applications. The value of any defined benefits are calculated as 20 times the annual pension they would have been entitled to on 5/4/16, assuming entitlement arose on that date, plus any TFC payable other than by commutation. The value of any money purchase benefits is simply the value on 5/4/16. You also need to take into account any previous BCEs and any pre A-day benefits as detailed in our article here:

Individual protection 2014 and 2016 

If the client is eligible they then get a protected LTA equal to the value of their benefits on 5/4/16 up to a maximum of £1.25m. 

Fixed protection 2016 – to be eligible the client needs to have made no contributions or had any relevant benefit accrual after 05/04/16. Applications can be made irrespective of the current value of a client’s benefits and there is currently no end date for these. If eligible the client gets a protected LTA of £1.25m. Further information, including what is classed as benefit accrual, can be found in our article here:

Fixed protection 2012, 2014 and 2016 

Q.  My client has fixed protection 2016 and is looking to transfer their defined benefits valued at £1.6m to a money purchase arrangement. If they crystallise this can they get TFC on the full fund? 

A.  No, the maximum TFC a client can take is up to 25% of their available LTA. So, in this case 25% of £1.25m = £312,500. Therefore, if the client wants to fully crystallise they can take up to £1.25m (made up of £312,500 TFC and a residual drawdown fund of £937,500) which will use up 100% of their LTA. The remaining £350,000 is a LTA excess, and they have the following options: 

  • Take it as a lump sum after a 55% tax charge. If this option was chosen the scheme administrator would deduct tax of £192,500 and pay this to HMRC on the client’s behalf and the client would receive a payment of £157,500.

  • Use it to provide additional drawdown income after a 25% tax charge.  If this option was chosen the scheme administrator would deduct tax of £87,500 and pay this to HMRC on the client’s behalf and the residual fund of £262,500 would be designated to drawdown.  Any drawdown income would then be taxed at the client’s marginal rate in the normal way. 

Note – You should also bear in mind that the client will lose their FP16 if the transfer from the DB scheme is not a ‘permitted transfer’. The transfer will be classed as a permitted transfer providing, the value of the sums and assets received by the money purchase arrangement are actuarially equivalent to the rights being transferred, i.e. the scheme is not offering an enhanced transfer value which is higher than the value calculated by the scheme actuary. 

Q.  My client is eligible for both fixed and individual protection 2016. Can they apply for both and is there any benefit in doing so? 

A.  Yes, they can apply for both and if they are eligible there is no harm in doing so as they then have IP16 to fall back on in case they inadvertently make a contribution which results in them losing their FP16. 

Q.  My client has just applied for FP/IP16 now but they have already had a BCE after April 2016, how will this be treated? 

A.  There have been various discussions around this subject and a number of providers had asked HMRC to provide guidance and clarity on this scenario. HMRC published an update in PSN82 (item 7) to help clarify this: 

https://www.gov.uk/government/publications/pension-schemes-newsletter-82-november-2016/pension-schemes-newsletter-82-november-2016

Our interpretation of this is that as FP16 and IP16 are effective from 6 April 2016, regardless of when they are actually applied for, then any BCE that has taken place after 6 April 2016 needs to be reworked based on the client’s protected LTA amount.  

Q. My client has IP16 and a protected LTA of £1,163,000.  On 6 June 2016 they took benefits from a defined benefit scheme in the form of a scheme pension of £6,650 and no TFC. If they take no further benefits until age 75 and assuming the standard LTA has increased to £1,222,000 by this time, how much TFC can they take?  Do they still have 25% of their protected LTA of £1,163,000 or 25% of £1,222,000?

A. They can take up to 25% of their available LTA. Taking the scheme pension used up 20 x 6650/1,163,000 = 11.43%, which means they have 88.57% left. Therefore, assuming the standard LTA is £1,222,000 which is higher than the client’s protected amount this would mean they had 88.57% of £1,222,000 = £1,082,325.40 and can take 25% of this = £270,581.35 (not 25% of £1,222,000 even though they took no TFC when they took their scheme pension as this still used up some of their LTA.)

Lifetime Allowance & Divorce

Q. Where a client’s pension is shared with their ex-spouse as a result of a pension sharing order is the pension debit amount tested against the original member’s lifetime allowance?
 
A. Where a pension debit is paid from funds put into payment after A-day, these will have used up some of the original member's lifetime allowance. The amount of LTA used is NOT reduced as a result of the pension sharing. If paid from uncrystallised funds, then the pension debit amount is not tested against the original member’s LTA. 

Q. Is a pension credit tested against the receiving member’s lifetime allowance?
 
A. Yes, a pension credit is always received as uncrystallised funds and will be tested against the receiving member's lifetime allowance when put in to payment. There are circumstances where the receiving member may qualify for a pension credit factor (effectively increasing their lifetime allowance) and you can read about these at PTM095200. Even though the funds are always received as uncrystallised no PCLS is payable if the pension credit is paid from previously crystallised funds (referred to as a disqualifying pension credit).

Q. How is a pension debit/credit tested for LTA purposes when the original member is over age 75 when the pension is shared?

Where the pension debit is paid after the original member has reached age 75 this will have been tested against their LTA at age 75 (even if the funds remain unused). If the receiving member is under age 75 the funds will be tested again when they put them into payment, reach age 75 or die before 75. However, if the receiving member is over age 75 there will be no further LTA test. (It should also be noted that this is not a disqualifying pension credit, even though there has been a BCE and the receiving member is entitled to a PCLS, providing they had sufficient remaining lifetime allowance at age 75 to allow it.

Q. If the original pension scheme member holds lifetime allowance protection, is this impacted by a pension debit?

A. It depends on the type of lifetime allowance protection held. Primary, Individual 2014 and Individual 2016 must be recalculated after a pension debit is paid, and may be lost. Enhanced and all Fixed Protections (2012, 2014 and 2016) are unaffected by a pension debit. 

Q. If the member receiving a pension credit holds lifetime allowance protection, is there any impact?

A. It depends on the type of lifetime allowance protection held. Primary, Individual 2014 and Individual 2016 are unaffected. Enhanced and all Fixed Protections (2012, 2014 and 2016) will be lost if the Pension Credit is set up in a new arrangement. This is covered at PTM093800

under the heading "Payment of a pension credit under a pension sharing order into a money purchase arrangement (personal pension scheme)”. 

Q. If the member receiving a pension credit will now face a lifetime allowance issue, what are their options?

A. They need to check to see if they are eligible to apply for any of the available lifetime allowance protection options. Further details of which can be found in our articles:

Individual protection 2014 and 2016

Fixed protections 2012,2014 and 2016 

Q. The pension debit member holds valid enhanced protection. The pension credit receiving member will now face a lifetime allowance issue. Can they adopt the original member's enhanced protection?

A. No. Lifetime Allowance protection only applies to the client who applied and is not transferrable.

Lifetime Allowance and Death

Q. My client has uncrystallised funds valued at £1.2m and no LTA protection, what would the LTA excess tax charge be if they die before age 75?

A. Where an individual dies before age 75 with uncrystallised funds, and provided the death benefits are distributed within the 2 year window, the full fund will be tested against the deceased member’s LTA. Based on the current value and assuming the deceased hadn’t previously used any of their LTA that would give an excess of £1,200,000-£1,030,000 = £170,000.

How this would be taxed depends on how the beneficiaries choose to have the benefits paid. Any benefits taken as dependant’s or nominee’s drawdown would be taxed at 25% and any benefits taken as a lump sum would have a 55% tax charge applied to the LTA excess.

Taking an example where the £1.2m was split equally between 4 different beneficiaries who took their benefits as follows:

Beneficiary A – £300,000 lump sum
Beneficiary B – £300,000 dependant’s drawdown
Beneficiary C – £150,000 lump sum and £150,000 nominee’s drawdown
Beneficiary D – £200,000 nominee’s drawdown and £100,000 lump sum

HMRC guidance states that the BCE’s are all treated as having occurred simultaneously to ensure that the LTA excess charge liability is distributed fairly across all the beneficiaries, so the excess and associated tax charge would be allocated as follows:

Beneficiary A is liable for 25% of £170,000, taxed at 55% = £23,375
Beneficiary B is liable for 25% of £170,000, taxed at 25% = £10,625
Beneficiary C is liable for 25% of £170,000, half of which is taxed at 55% and the other half is taxed at 25% = £17,000
Beneficiary D is liable for 25% of £170,000, two thirds of which is taxed at 25% and one third at 55% = £14,875     

Q. Where a LTA excess tax charge applies on death before age 75 does the scheme administrator deduct this before distributing the death benefits?

A. No, unlike where a LTA excess occurs during the member’s lifetime, on death the liability for the tax charge lies solely with the beneficiary. The legal personal representative of the deceased is responsible for gathering the necessary information to determine if there is a LTA excess and what the associated tax charge is. They must then inform HMRC who will contact the beneficiaries to arrange for payment of the tax. Further information can be found in this leaflet:

Death Benefits

Q. When are benefits tested/not tested against the deceased’s LTA on death?

A. Whether or not benefits are tested for LTA purposes on death depends on the type of benefit (i.e. if from a defined benefit (DB) or a money purchase (MP) arrangement), the deceased’s age at date of death and whether the benefits are settled within the 2 year window, as illustrated in the following table:

Benefit type

Death before/after 75

LTA test

Taxable/Tax-free to beneficiary

Lump sum DIS benefit (DB or MP)

Before 75

Yes

Tax-free

After 75

No

Taxable

Dependant’s scheme pension

Before 75

No

Taxable

After 75

No

Taxable

Uncrystallised MP funds

Before 75

Yes *

Tax-free *

After 75

No

Taxable

Crystallised MP funds

Before 75

No

Tax-free #

After 75

No

Taxable

*Benefits paid within the 2 year window are tax-free and tested against the deceased’s LTA, any benefits paid after 2 years will be taxable at the marginal rate of the beneficiary but there will be no LTA test.

#There is no further LTA test for crystallised funds and any benefits paid as income are always tax-free, however benefits paid as a lump sum are only tax-free if settled within the 2 year window. 

Q. Are beneficiary’s drawdown benefits ever tested again on the death of the dependant/nominee/successor or at age 75?

A. No, death benefits are only ever tested (if applicable) against the original deceased member, there are no further LTA tests at any point on the recipient of the benefits.  

Q. Does taking income from a dependant’s/nominee’s/successor’s flexi-access drawdown plan trigger the money purchase annual allowance?

A. No.

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