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Lifetime Allowance

The Lifetime Allowance was first introduced in April 2006  – effectively capping the total tax privileged retirement savings which an individual is able to accrue in UK registered pension schemes. Initially set at £1.5M  it had risen to £1.8M by 2011 but has since reduced to £1.0M.

Everyone is  able to fund their pension savings up to the Annual Allowance – assuming of course that they can afford to do so.

However, exceeding the Lifetime Allowance will  trigger some unwelcome tax charges as explained below.

When benefits are withdrawn from a registered pension arrangement this is referred to as a ‘crystallisation event’ and triggers a test against the Lifetime Allowance and any excess is subject to a ‘recovery tax’ charge.

The rate of tax depends upon the way in which the excess benefits are taken, as follows:

  • 25% if the excess is left in the pot to be taken as taxable income, or
  • 55% if the excess is taken out as a lump sum.

Despite the apparently anomalous difference, the outcome is designed to be tax-neutral for a 40% tax payer. This is because after suffering the 25% recovery tax subsequent withdrawals from  the residual fund would then be subject to income tax at 40%. Apply the two taxes in sequence and they equate to a combined rate of 55%.

In valuing benefits for the purposes of testing them against the Lifetime Allowance, money purchase funds are simply taken at face value whilst defined benefit/final salary pensions are capitalised using a factor of 20:1. Pensions already in payment also count towards the Lifetime Allowance and are valued using a factor of 25:1 (the higher factor is based on the supposition that in addition to the pension, the individual probably also took a tax free lump sum at retirement).

Transitional Protection

Fortunately the Government realised that the imposition of the Lifetime Allowance could have a retrospective effect on anyone who had already built up substantial pension benefits before the  rules were introduced.

To prevent such people being unfairly subjected to the new tax charge, the legislation allowed them to register their existing benefits for one of two types of transitional protection, Primary or Enhanced Protection

Primary Protection

Primary Protection was only available to those who had existing pension rights worth more than £1.5 million as at 6th April 2006. By registering these benefits with HM Revenue & Customs, only additional pension rights built up after that date are deemed to be excessive and subjected to the recovery tax charge.

Therefore, anyone with Primary Protection is subject to a ‘Personal Lifetime Allowance’ instead of the ‘Standard Lifetime Allowance’.

For example someone who had pension benefits worth £3 million in April 2006 and claimed Primary Protection will have a Personal Lifetime Allowance equal to twice the Standard Lifetime Allowance.

Enhanced Protection

Anyone was able register for Enhanced Protection regardless of the value of their benefits. This approach involved undertaking to accrue no further ‘relevant benefits’ after 6th April 2006 in which case existing pension rights will never be tested against the Lifetime Allowance nor be subject to the recovery tax charge.

Payment of any contribution to a money purchase pension arrangement after 6th April 2006 will immediately invalidate any claim for Enhanced Protection.

However, continuing to participate in, or contribute to, a defined benefit/final salary pension scheme does not necessarily invalidate the claim. That is because, in these types of scheme, establishing whether ‘relevant benefit accrual’ has occurred is an output test measured not by contributions paid into the scheme but by the growth in the value of the benefits paid out at retirement relative to their value at April 2006.

Fixed Protection

The Finance Act 2011 reduced the  then Lifetime Allowance of £1.8m to £1.5m from 6th April 2012. It was however possible to retain the higher £1.8m Lifetime Allowance by ceasing all future benefit accrual and/or contributions after that date and claiming “Fixed Protection”.

Fixed Protection 2014

The Finance Bill 2013 further reduced the Lifetime Allowance to £1.25m with effect from 6th April 2014. Once again however It is  possible to retain the higher £1.5m Lifetime Allowance by ceasing all future benefit accrual and/or contributions after that date and claiming “Fixed Protection 2014”.

Individual Protection 2014

The Finance Bill 2013 also introduced a form of transitional protection known as Individual Protection. This has two potential uses:

1. Anyone with benefits valued between £1.25M and £1.5M as at 6th April 2014 can retain a personal lifetime allowance equal to that valuation.

2. Because there is no requirement to cease benefit accrual, anyone with benefits greater than £1.5M could retain that level of Lifetime Allowance and continue to make further pension provision without invalidating their protection.

Fixed Protection 2016

On 6th April 2016 the Standard Lifetime Allowance reduced to £1.0M.

Again it was possible to retain the higher £1.25M Lifetime Allowance by ceasing all future benefit accrual and/or contributions after that date and claiming “Fixed Protection 2016”.

Individual Protection 2016

Anyone with benefits valued between £1.0M and £1.25M as at 6th April 2014 can retain a personal lifetime allowance equal to that valuation.

Because there is no requirement to cease benefit accrual, anyone with benefits greater than £1.0M can retain that level of Lifetime Allowance and continue to make further pension provision without invalidating their protection.

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