Pension Lifetime Allowance

From 6 April 2006 pension rules changed significantly, in particular the rules around the maximum benefits payable under UK tax approved pension schemes.

Although there were no limits on the benefits an individual could receive – or 'crystallise' - from registered pension schemes, there was an overall limit of tax privileged pension funds a member could crystallise during their lifetime – called the 'Lifetime Allowance' (LTA).

When a member took certain benefits and at some other times (such as attaining the age of 75 or on death before 75) the amount of LTA they had used was tested.

When the members' benefits, along with any other benefits they had taken, were over the LTA, a 'Lifetime allowance charge' was applied to the value in excess of the LTA.

When members took benefits from registered pension schemes (crystallise benefits), they used up a proportion of their LTA. If the individual took more benefits later, the additional benefits were tested against the remaining proportion of the member's LTA.

Where given as a percentage it is rounded down to two decimal places e.g. 28.777 is 28.77% NOT 28.78%. However, care should be taken when using only the percentages as this will prove inaccurate in certain conditions (see below for example).

Pension Tax Manual PTM081000 & PTM164400

The correct method for calculating LTA usage required the past crystallised amount be indexed at the same rate the standard LTA had been indexed. This was done with the formula:

RUA x (CSLA/PSLA)

Where:

RUA - Relevant Untaxed Amount - the amount of the previous BCE
CSLA - Current Standard Lifetime Allowance - Standard LTA today
PSLA - Previous Standard Lifetime Allowance - LTA at the time of the previous BCE

Finance Act 2004, Section 219

Note that for the purpose of calculating an individual's LSA and LSDBA under the post 5th April 2024 regime the percentage method is used.

When a BCE occurred, the value crystallised was measured for LTA purposes – the capital value of this amount depended on the type of event taking place - see below.

There were originally 9 BCEs and 13 when the LTA was abolished.

The table below summarises all the Benefit Crystallisation Events and the value for LTA test purposes.

• 1 - RVF = Relevant Valuation Factor, i.e. 20 or if higher, an alternative factor agreed with HMRC
   

• 2 - P = the amount of the pension which will be payable to the individual in the period of 12 months beginning with the day on which the individual becomes entitled to it (assuming that it remains payable throughout that period at the rate at which it is payable on that day).
   

• 3 - XP = the amount by which:(a)the increased annual rate of the pension, exceeds (b)the rate at which it was payable on the day on which the individual became entitled to it, as increased by the permitted margin.
  
  

• 4 - DP = the annual rate of the scheme pension to which the individual would be entitled if, on the date on which the individual reaches 75, the individual acquired an actual (rather than a prospective) right to receive it.
   

• 5 - DSLS = the amount of any lump sum to which the individual would be entitled (otherwise than by way of commutation of pension) as would be paid to the individual if, on that date, the individual acquired an actual (rather than a prospective) right to receive it.
   

Benefit Crystallisation events were largely abolished and replaced by RBCEs at 6th April 2024 but some mentions still exist in relation to annual allowance in the post abolition world. 

The lifetime allowance system was supported by an information exchange and reporting regime. There were different systems for reporting and paying the lifetime allowance charge depending on whether the BCE occurred during the member’s lifetime or as a result of a BCE after the death of the member. The member needed to be told by the scheme administrator (or an insurance company if they administer the scheme), via a BCE statement the following information:

• how much lifetime allowance had been used up by the BCE. This information was required so that the member could work out the remaining LTA available for future BCE’s and correctly complete any tax returns
  
• if there was a liability to the lifetime allowance charge and if so, whether the scheme administrator had paid or intended to pay part or all of the tax due
  
• If an insurance company was paying a scheme pension or lifetime annuity using funds that derived from a registered pension scheme, they had to tell the member annually how much lifetime allowance had been used up in respect of those benefits
   

Where the scheme administrator wasn't required to provide an annual BCE statement for the tax year, they were required to provide the required information within three months of a BCE that had occurred under the scheme in respect of the member.

Where, following the death of a member, the scheme administrator paid a defined benefits lump sum death benefit, or an uncrystallised funds lump sum death benefit they had to supply the following information to the deceased members personal representative within 3 months of making the payment: 

• The amount of lump sum
• The payment date
• The percentage of the standard LTA used by the payment
   

Where, following the death of a member, funds were designated to provide a dependant’s or nominee’s flexi-access drawdown fund (BCE5C), or the beneficiary(ies) became entitled to a dependant’s or nominee’s annuity from unused uncrystallised funds (BCE5D) the scheme administrator had to provide the following information to the deceased member’s personal representative within 3 months (remember the scheme administrator was not responsible for deducting any LTA excess tax charges from these BCEs. 

The information that had to be provided on a BCE 5C was:

• the amount designated
  
• the date of designation, and
  
• the percentage of the standard LTA used up by the BCE 5C.
   

The information that had be provided on the BCE 5D was:

• the amount or market value of assets applied to the purchase of the annuity
  
• the date the person became entitled to the annuity, and
  
• the percentage of the standard LTA used up by the BCE 5D.
   

 Pensions Tax Manual PTM164100, PTM165100

As a result of the abolition of the lifetime allowance all schemes had to write to all members of their scheme who had uncrystallised rights as at 5th April in their scheme and had used up some LTA in that scheme.  This one-off statement had to be issued in the 2024/2025 tax year and was to allow members to ascertain their transitional allowance usage under the post 5th April 2024 regime. 

Drawdown contracts that started before 6 April 2006 were exempt from any further BCEs (other than at the first BCE after April 2006, to determine remaining LTA, as detailed in the pre-commencement pension section above).

If the member was alive, the Scheme Administrator had check the amount crystallising each time there was a BCE to ensure that the appropriate tax was paid on any funds taken above the LTA. The Scheme Administrator had to calculate the capital value of the benefits coming into payment, to verify the percentage of the LTA being used. As discussed above, the method of doing this depended on the BCE.

If the percentage of the LTA crystallising was greater than the percentage available, the excess became a 'Chargeable amount' and the 'Lifetime allowance charge' applied.

The tax rate depended on whether the excess was paid as a lump sum - called a Lifetime allowance excess lump sum and charged at 55% - or if retained to pay pension benefits, charged at 25% (tax is then payable on the income the member receives at their marginal rates).

If the member was alive, the liability for paying the LTA charge fell jointly on the Scheme Administrator and the member. Normally, the Scheme Administrator was obliged to deduct the tax charge before a 'retirement' payment was made. If, however, the charge arose on the member's death, the recipient of the payment was liable.

The scheme administrator had to  pay, and account for, the LTA charge to HMRC on a quarterly basis (through the Accounting for Tax Return).

Where a chargeable amount applied, the scheme administrator had to send the member a notice showing;

• the level of the Chargeable amount;
  
• how this was calculated; and
  
• the level of LTA charge deducted (or how they proposed the tax due should be paid).
   

The provider could have become liable for any LTA charge not paid. The provider could have been liable, potentially, for additional charges and fines, unless they had evidence that they acted on information from the member that was believed to be reliable.

In these circumstances, specific information had to be provided to HMRC within certain time limits. If they consider that the scheme administrator acted in good faith, then the member becomes solely liable for the charge.

Finance Act 2004 - S214 - 226, Sch 32

In the 2023/2024 tax year, as the first steps to the abolishment of the LTA the 55% tax charge was changed to a marginal rate tax charge and the 25% tax charge was changed to 0%.