Out-Law Guide | 25 Oct 2019 | 11:45 am | 2 min. read
Where an individual's benefits under their registered pension schemes exceed the lifetime allowance, a tax charge, known as the lifetime allowance charge, becomes payable.
Scheme administrators need to test whether a member has exceeded the lifetime allowance only when a "benefit crystallisation event" occurs. That usually means when the member starts drawing their pension benefits. Scheme administrators must ask the member about their other pension savings since they may already have used up some of their lifetime allowance.
Pensions payable under a defined benefit scheme are converted into a cash value in accordance with HMRC guidance. A conversion factor of 20 is generally used: a pension of £10,000 a year would have a cash value for lifetime allowance purposes of £200,000.
When excess over the lifetime allowance is used to provide a pension it is taxed at 25%. If used to provide a lump sum, the excess is taxed at 55%. Scheme rules usually allow members to take the excess as a lump sum, but legislation prevents contracted-out benefits being paid out in this way.
Usually, the scheme administrators deduct any lifetime allowance charge payable from the scheme member's benefits and pay HMRC on their behalf. The member will still need to report this in their self-assessment tax return.
Some individuals benefit from non-standard lifetime allowances. On the introduction of the lifetime allowance in 6 April 2006, individuals were able to apply for an increased lifetime allowance based on their then pension savings (primary protection) or they could take themselves outside the lifetime allowance regime (enhanced protection). Similarly, individuals were able to retain a lifetime allowance of £1.8 million after 5 April 2012 by applying for fixed protection. And individuals were able to retain a lifetime allowance of £1.5 million after 5 April 2014 by applying for fixed protection 2014. They also had until 6 April 2017 to apply for individual protection 2014, which would give them a lifetime allowance based on their pension savings on 5 April 2014 (up to £1.5 million).
Similar protection was introduced in relation to the further drop in the lifetime allowance on 6 April 2016 to £1 million.
The important point to remember is that fixed protection, fixed protection 2014, fixed protection 2016 and enhanced protection are lost if the individual builds up any additional benefits under any registered pension scheme.
Employers are generally required to enroll their workforce into a pension scheme. Employers may auto-enrol workers who have fixed protection, fixed protection 2014, fixed protection 2016 or enhanced protection. Those workers should opt out of the pension scheme within the one month deadline to ensure they do not lose the protection. Employers can decide not to auto-enrol workers with relevant protection, assuming those workers can be identified.
Trustees and employers will not necessarily know whether their scheme members are affected by the lifetime allowance. This is because members may have pension savings under schemes provided by previous employers. Trustees should therefore make generic information about the lifetime allowance available to their members so that the members themselves can decide whether the lifetime allowance is relevant.