Introduced as part of “pension simplification” in April 2006, the lifetime allowance (LTA) – and the planning that surrounds it – is actually far from straightforward. This is especially so given the constant changes made to the allowance over the years. When it was introduced on 6 April 2006, the standard allowance was set at £1.5 million with annual increases planned for every tax year. By the beginning of the 2010/11 tax year, the standard LTA had increased to £1.8m. But this is as high as the allowance ever got.

Until this point, the LTA was rarely discussed as it only affected a very small proportion of the population. However, since 2011/12, the standard LTA has been reduced significantly and by April 2016 it was set at just £1 million. From 2018/19 to 2019/20, it started to increase each year in line with Consumer Price Inflation (CPI) to reach the current level of £1,073,100. But, in his March 2021 budget, the Chancellor of the Exchequer announced that the LTA would not be increased any further until at least April 2026.

Given this backdrop, it’s understandable why the number of individuals affected by the LTA has grown significantly over recent years. It is often a key consideration for advisers as part of their financial planning with clients. Although there is no limit on the value of authorised benefits that a pension scheme can provide to its members, an individual has a single LTA.

This allowance relates to the amount of tax-privileged benefits that the person can draw (crystallise) from their pension schemes before an LTA tax charge is applied.

From a planning perspective, the LTA means we not only have to forecast the value of a client’s pension savings – and how and when they are likely to take benefits – but also what their LTA could be at that time. This could involve planning up to and including the client’s 75th birthday. It may not always be possible, or even preferable to avoid exceeding the LTA. However, by ensuring that a client has utilised any LTA protection or available enhancements and by considering how these benefits are taxed, we may be able to reduce the impact.

Lifetime Allowance Protection

It is easy to forget that individuals can still apply for two protections:

1. Fixed Protection 2016 (FP16) – this provides a minimum LTA of £1.25 million and may be available if the client has not accrued further pension benefits after 5 April 2016. 

2. Individual Protection 2016 (IP16) – this is available if the client had pension savings valued at more than £1 million as at 5 April 2016. The value of the LTA will be the higher of the pension savings at that date, or the current standard lifetime allowance, subject to a maximum of £1.25 million.

Regardless of whether the individual has a protected LTA or the standard LTA, the allowance can be boosted further by applying for an enhancement if available. 

Lifetime allowance enhancements

Typically, an LTA may be enhanced in three scenarios:

1. Pension Credit factor – where an individual receives a pension credit as a result of a pension sharing order and part or all of the benefits received have previously been crystallised.

2. The recognised overseas pension scheme transfer factor – where the individual transfers the benefits from a recognised overseas pension scheme to a UK-registered pension scheme.

3. Non-residence factor – where the individual is an active member of a UK-registered pension scheme, but are non-resident for UK tax purposes.

The qualification rules, particularly for overseas pension transfers and non-residence, can be quite complex and further detail can be found in HMRC’s  Pension Tax Manual (PTM095000). It is important to note that, where an individual qualifies for an LTA enhancement, HMRC will need to be notified no later than five years after 31 January following the tax year in which they qualified for the enhancement. 

Lifetime allowance tax charges

Where someone’s LTA has been fully utilised, 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 55%. However, broadly speaking, there are normally only two events that will trigger this tax rate:

  • Where an individual is under age 75 and withdraws LTA excess benefits as a lump sum payment.  
  • Where the individual dies before age 75 with uncrystallised pension funds that exceed the individual’s available LTA and the pension benefits are paid out as a lump sum (within the two-year relevant period).

This second example could be avoided by ensuring that beneficiary flexi-access drawdown (BFAD) is available to receive the pension benefits. For all other events, the LTA tax charge is normally 25%. Income tax may still apply to any withdrawals (except for BFAD if death occurs before age 75) and would be payable at the individual’s marginal rate in the year that income is received. 

Good advice may mitigate any tax charge

The reduction in the standard LTA to the current level of £1,073,100 – and the freezing of this level until 2026 – will undoubtedly mean that even more individuals will potentially incur the LTA tax charge. However, as we’ve seen, skilful planning may allow clients to reduce or even negate any tax charge. Ensuring your clients, where appropriate, have applied for any LTA protection or available enhancements is the first step. But even where an LTA tax charge cannot be avoided, considering how these benefits may be tested may mean that they are subject to the 25% tax rate – rather than the 55% tax rate.

As I mentioned upfront, the LTA is a complicated area. If you need to know more about the intricacies of the LTA and how the tax charge works, we’ve produced an in-depth technical guide, as well as an LTA checklist to aide financial planning. Simply visit the Pensions 'in-depth': the lifetime allowance area of our website to download your copy.

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