Lifetime allowance explained

What is a lifetime allowance?

A lifetime allowance is the maximum value of benefits an individual can take from all the registered pension schemes before he /she has to pay a lifetime allowance tax charge. When an individual avails all the benefits, they are tested against the available personal lifetime allowance. If a person exceeds this, a lifetime allowance tax charge will be payable on the exceeded value – this is currently 55% for lump sum, and 25% for funds used to purchase pension income (which is taxable under the Pay-as-you-earn (PAYE) system).

Standard or personal lifetime allowance

The basic standard or personal lifetime allowance for the 2016/17 tax year is £1.0mn. However, if an individual has certain types of tax protection they will have a higher standard lifetime allowance:

• £1.8mn if an individual has fixed protection 2012
• £1.5mn if an individual has fixed protection 2014
• £1.25mn if an individual has fixed protection 2016

For the current tax year 2017/18, the lifetime allowance for most people is £1.0mn and applies to the total of all the pensions an individual has, including the value of pensions assured through any defined benefit schemes a person belongs to, excluding the State Pension. From 6 April 2018, the government aims to index the personal Lifetime Allowance in line with the Consumer Prices Index (CPI).

Understanding the allowance

Each time payout begins from an individual’s pension schemes, the payout is evaluated against the remaining lifetime allowance to analyse if there is additional tax to be paid. An individual can compute whether he / she are likely to be impacted by adding up the expected value of payouts. Also, the value of pensions is computed differently depending on the type of scheme a person is in:

• For definite contribution pension schemes, including all personal pensions, the value of an individual’s benefits will be the value of pension pot used to fund the retirement income and any lump sum
• For defined benefit pension schemes, compute the total value by multiplying the expected annual pension by 20. Additionally, add to this the amount of any tax-free cash lump sum. In numerous schemes, people might only get a lump sum by giving up some pension, where the value of full pension captures the full value of payouts. Hence, a person is likely to be impacted by lifetime allowance in 2017-18 if final salary pension is more than £50,000 a year or a salary-related pension is in excess of £37,500 plus the maximum tax-free cash lump sum

If the cumulative value of the payouts from the pension pots, including the value of the payouts, exceeds the lifetime allowance, there will be tax on the excess – referred to as lifetime allowance charge. The manner in which the charges apply depends on whether an individual receives the pension amount as a lump sum or as part of regular retirement income.

Change in Lifetime allowance (comparison)

Tax year	Amount (£mn)	Change (%)
2006/07	1.50	-
2007/08	1.60	6.7%
2008/09	1.65	3.1%
2009/10	1.75	6.1%
2010/11	1.80	2.9%
2011/12	1.80	0.0%
2012/13 & 2013/14	1.50	-16.7%
2014/15 & 2015/16	1.25	-16.7%
2016/17 & 2017/18	1.00	-20.0%

Taxed as Lump sums

Any amount above the lifetime allowance that an individual can take as a lump sum is taxed at 55%. The pension scheme administrator is responsible to deduct the tax and pay it to HM Revenue and Customs (HMRC), and paying the balance back.

Taxed as Income

Any amount over the lifetime allowance that a person takes as a regular retirement income (example, buying an annuity) attracts a lifetime allowance charge of 25%. This is in addition to any tax payable on the income in the usual way. For definite contribution pension schemes, a pension scheme administrator should pay the 25% tax to HMRC out of the pension pot, leaving the remaining 75% to be put towards retirement income. For example, suppose a person pays tax at the higher rate had expected to get £2,000 a year as income but the 25% lifetime allowance charge reduced this to £1,500 a year. After deducting income tax at 40%, the person would be left with £900 a year. This means the lifetime allowance charge and income tax collectively have reduced the income by 55%. For defined benefit pension schemes, the pension scheme might decide to pay the tax on an individual’s behalf and recover it from a person by reducing the pension.

Individual Protection 2016

Individual Protection 2016 (IP2016) is only available if the value of the pension savings on 5 April 2016 was in excess of £1.0mn. IP2016 is also available for individuals who already have protection under the Enhanced Protection, Fixed Protection 2012, Fixed Protection 2014 or Fixed Protection 2016 schemes. An individual can make the application online with HM Revenue & Customs (HMRC). Launched in July 2016, the online system came into effect after the new reduced lifetime allowance came into effect. Hence, a person applying for IP2016 will need to make sure they do not have pension accrual after 5 April 2016. It’s advisable to speak to DNS Accountants for more information with regards to applying for IP2016. There is no submission deadline for IP2016.

IP2016 provides a protected lifetime allowance equal to the value of pension savings on 5 April 2016 which is subject to an overall maximum of £1.25mn. The IP rules are complex and an IP can be lost depending on if the retirement income for an individual including lump sums is made available under a defined contribution, or a defined benefit pension scheme.

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