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The lifetime allowance is the maximum amount of pension and/or lump sum that you can get from your pension schemes that benefit from tax relief. There is no limit on the amount of benefits that your pension scheme can pay you. However, if your pension scheme gives you benefits of more than your lifetime allowance you will pay an extra tax charge on the amount over your lifetime allowance. This tax charge is called the lifetime allowance charge.
The lifetime allowance does not affect the amount of benefits provided by your pension scheme. But as it can affect the amount of tax that you pay, your 'take home' benefits will be less if you have to pay the lifetime allowance tax charge.
The amount of the lifetime allowance for 2010-11 and 2011-12 was £1.8 million. The amount of the lifetime allowance for 2012-13 has reduced to £1.5 million. Despite this reduction, most people will not be affected by the lifetime allowance charge as they do not have pension savings of more than £1.5 million.
Most people will not be affected because their benefits will be less than the lifetime allowance. To receive benefits of more than the lifetime allowance:
If you already get a pension that has been paid since before 6 April 2006 then you will need to take this into account when working out if your pension savings are more than the lifetime allowance. The amount of pension savings that you can have before you are affected by the lifetime allowance will be less than the above amounts.
Read more about calculating the value of your pension savings
However, if your benefits are more than the lifetime allowance then a tax charge will apply. This is called the lifetime allowance charge.
Find out more on how you might be affected
Xavier is a member of a final salary pension scheme. At 5 April 2012 Xavier is 55 and has built up a pension of £50,000. Xavier plans to retire at age 60. Based on his current level of pensionable pay, Xavier will have built up a pension of £60,000 when he plans to retire. To see if his benefits will be more than the lifetime allowance, Xavier will need to multiply his pension entitlement by a factor of 20 to get a capital value to compare to the lifetime allowance.
On 5 April 2012, Xavier's benefits are valued as
£50,000 x 20 = £1 million.
At Xavier's planned retirement date his benefits would be worth
£60,000 x 20 = £1.2 million.
So his benefits at retirement will be less than the reduced lifetime allowance of £1.5 million.
Samina is a member of a pension scheme which gives her a pension of 1/80th of final salary for each year of service and a separate lump sum of 3/80th of final salary for each year of service. At 5 April 2012 Samina has built up a pension of £60,000 and a separate lump sum of £180,000. On this day Samina leaves the scheme but does not take her benefits. Samina plans to take her benefits on her 60th birthday - 8 April 2014. Under the scheme rules Samina's deferred benefits are increased by 3 per cent a year during the period of deferral.
Samina knows that when she plans to take her benefits they will be a pension of £63,654 and a lump sum of £190,962.
The value of Samina's benefits when she retires on 8 April 2014 for lifetime allowance purposes is
£63,564 x 20 + £190,962 = £1,462,242.
Samina's benefits are less than the reduced standard lifetime allowance of £1.5 million.
On 1 June 2011 Andy has £1,000,000 in a self invested personal pension fund (SIPP) to which he is contributing £20,000 per annum. He is not a member of any other pension scheme. Andy wants to take his benefits in three years time in June 2014 and wants to work out if the reduced lifetime allowance affects him.
To be more than the lifetime allowance Andy's pension fund would have to increase by more than £500,000 in value in three years. Andy decides this is unlikely to happen so he continues his contributions.
At certain times the value of your benefits will be tested to see if they are more than your lifetime allowance. The time at which the value of your benefits is tested against the lifetime allowance is called a benefit crystallisation event (BCE). For most people their BCE(s) will occur when they start to take benefits. For example, this can happen when your pension comes into payment, when you use your pension savings to buy an annuity or when you start drawing down income from your pension fund.
The circumstances in which a BCE occurs and how benefits are valued at a BCE have not changed. If you want to find out more about BCEs see the section of Registered Pension Schemes Manual (RPSM) at RPSM11104000.
When a BCE occurs your scheme administrator must be satisfied that there is no lifetime allowance charge. If the value of pension savings in your pension scheme is above the lifetime allowance, your pension scheme will normally deduct the tax due and pay this to HM Revenue & Customs (HMRC). If they do not do this they may have to pay extra tax and penalties to HMRC.
There is no set way in which your pension scheme carries out this lifetime allowance test. Your pension scheme administrator may ask you for full details of any benefits you have previously taken from the scheme or from any other registered pension scheme. Or they may simply ask you to confirm that your total benefits will not be more than the normal lifetime allowance.
If you do not give your pension scheme administrator the information they need to carry out this lifetime allowance test your scheme could choose to delay paying your benefits. Alternatively your scheme administrator may decide to pay your benefits on the basis that you have used up all your lifetime allowance, and so deduct the lifetime allowance charge before paying your benefits.
After a BCE your pension scheme administrator will tell you what percentage of the lifetime allowance the BCE has used up. If your scheme is paying you a pension it will give you this information again at least once a tax year. Many schemes choose to add this information to the P60 they send you after the end of each tax year telling you how much Income Tax has been deducted from your pension. This information should be given to everyone who has had a BCE - even if they do not have to pay the lifetime allowance charge.
When you start your first pension your pension scheme administrator will work out the value of your benefit crystallisation event (BCE). This is the amount of the lifetime allowance you have used up. Your pension scheme administrator will then convert this amount into a percentage of the lifetime allowance.
If you have used up more than 100 per cent of the lifetime allowance:
If you have not used up more than 100 per cent of the lifetime allowance:
When you start your first pension your pension scheme administrator will work out the value of the benefit for lifetime allowance purposes. This is the amount of the lifetime allowance you have used up. If you take a tax free lump sum (known as a pension commencement lump sum) this will be a separate BCE. Your pension scheme administrator will then convert this amount into a percentage of the lifetime allowance and tell you what it is.
When your next pension comes into payment the pension scheme administrator will work out the value of your BCE. Again this will be converted into a percentage of the lifetime allowance. The value of all your BCEs will be added together. If you have used up more than 100 per cent of the lifetime allowance you will be liable to the lifetime allowance charge on the amount over the lifetime allowance.
This process is repeated every time you start to take benefits and have a BCE.
Alan is a member of two pension schemes. Alan takes benefits from scheme A on 8 April 2012. He takes benefits from scheme B on 1 November 2012. Alan takes a lump sum and pension from both schemes.
Alan has not previously used up any of the lifetime allowance. He tells the scheme administrator he has 100 per cent of the standard lifetime allowance available.
The scheme administrator calculates the combined value of the pension and lump sum benefits to be paid on 8 April 2012 as £1.2 million. This is 80 per cent of the standard lifetime allowance of £1.5 million for the 2012-13 tax year. As Alan has only used up 80 per cent of his lifetime allowance there is no lifetime allowance charge. The scheme administrator gives Alan a certificate telling him that he has used up 80 per cent of the standard lifetime allowance.
On 1 November 2012 Alan becomes entitled to benefits under scheme B. The scheme administrator of scheme B values the benefits as £450,000 for lifetime allowance purposes. This is 30 per cent of the £1.5 million standard lifetime allowance. Alan tells scheme administrator B that he has already used up 80 per cent of the standard lifetime allowance.
Scheme administrator B now knows that Alan only has 20 per cent of the standard lifetime allowance available. The benefits from scheme B are worth 30 per cent of the current standard lifetime allowance. Scheme administrator B works out that £150,000 of Alan's benefits is subject to a lifetime allowance charge.
Alan chooses to take the £150,000 liable to the lifetime allowance charge as a lump sum. This would be subject to a lifetime allowance charge of 55 per cent. The scheme administrator deducts the 55 per cent from the £150,000 lump sum and pays Alan the remaining £67,500.
Scheme administrator B pays HMRC the lifetime allowance charge. Scheme administrator B also tells Alan:
Alan can use this information to complete his Self Assessment return.
Until 5 April 2012 you could tell HMRC that you wanted protection from the effects of the reduction in the lifetime allowance. This 'fixed protection' protects pension savings up to £1.8 million from the lifetime allowance charge. However, to keep this protection you have to meet certain conditions. These include:
If you have not told HMRC that you wanted to rely on fixed protection by the deadline of 5 April 2012 then you will have a lifetime allowance of £1.5 million
You are not entitled to fixed protection if you have enhanced or primary protection.
Find out more about fixed protection
To decide if your pension savings are above or below the lifetime allowance, you need to work out the value of your pension savings for all the pension arrangements under all the registered pension schemes that you belong to and add these together.
How you value your pension saving depends on whether your pension is already in payment and for benefits not yet in payment, the type of pension arrangement that you belong to.
The type of arrangement you belong to depends on the type of benefit you have been promised. You can be in more than one type of arrangement under the same pension scheme.
Find out more about which type of arrangement you belong to
If your pension started to come into payment after 5 April 2006 then a benefit crystallisation event (BCE) occurred when you became entitled to it. So your pension will already have been measured against the lifetime allowance. Your pension scheme administrator will give you a certificate each year telling you what percentage of the lifetime allowance your pension (and any connected tax free lump sum) has used up.
If your pension started to come into payment before 6 April 2006 how it is valued depends on if you have received any new benefits on or after that date.
If you have not taken any more benefits then the value of your pension savings is 25 times the annual rate of the pension in payment.
If you have received other pension benefits since 6 April
2006 then the value of your pension savings is 25 times the
annual rate of the pension in payment at the first date on or
after 6 April 2006 that you became entitled to these new benefits.
If the pre 6 April 2006 pension in payment is income drawdown
then the annual pension rate is the maximum you can draw down.
Your pension provider will have told you how much this is.
For savings in money purchase and cash balance arrangements the value is the value of the funds in your arrangement. Your pension scheme administrator will provide you with details of this value once a year.
For a defined benefits arrangement, the value is 20 times the pension you expect to get when you retire plus any separate lump sum that you are entitled to.
For example, Claire belongs to a defined benefits arrangement and expects her pension to be £30,000 per annum when she retires. The scheme also provides a lump sum of three times pension at retirement.
For lifetime allowance purposes, the value of her pension savings is 20 × £30,000 + 3 × £30,000 = £690,000.
If you have to give up some of your pension in return for a lump sum (commutation) then, for lifetime allowance purposes, you use the value of the pension before commutation because you will not know at this stage what lump sum you will take. So any lump sum you can choose to take by giving up part of your pension is not included in the calculation.
For example, Janet is in a defined benefits arrangement and expects her pension to be £35,000 when she retires. Janet's scheme allows members to exchange (commute) part of their pension for a tax-free lump sum. Each £1 of pension commuted converts into £12 lump sum and she intends to take a pension of £30,000 and a lump sum of £60,000. For lifetime allowance purposes, the value of her pension savings is 20 × £35,000 = £700,000.
If you are a member of more than one scheme, you should work out the value for each scheme and then use the total from all of these to decide if you have exceeded the lifetime allowance.
Primary protection and enhanced protection are the two methods whereby individuals could protect pension rights accrued before 6 April 2006. The closing date for applying for these protections was 5 April 2009 so you can no longer normally apply for them.
Primary and enhanced protection will continue. The reduction in the standard lifetime allowance will not change how enhanced protection works. If you have primary protection the amount of your benefits protected from the lifetime allowance will not change.
If you have enhanced or primary protection you are not entitled to fixed protection.
Read more about primary and enhanced protection
Your pension scheme administrator should work out if you are within your lifetime allowance each time that you take benefits from the scheme.
The rate of the lifetime allowance charge depends on how you take your benefits. The tax rules allow you to take any of your benefits over your lifetime allowance as either a lump sum or as a pension (or as a mixture). However your pension scheme rules may restrict how you can take your benefits.
Any amount over your lifetime allowance taken as a lump sum is taxable at 55 per cent.
Any amount over your lifetime allowance taken as a pension is taxable at 25 per cent.
For example, on 30 June 2012 Paul has a personal pension fund of £2.5 million. This is £1 million more than the lifetime allowance of £1.5 million. Paul decides to use his pension fund to buy an annuity. Paul's options are:
The tax rate for lump sums (55 per cent) is higher because a lump sum payment will not be taxed later. Where the excess over the lifetime allowance is paid as a pension the continuing pension will be taxable on the member. The lower 25 per cent lifetime allowance charge plus the likely Income Tax on the continuing pension normally gives an effective tax rate of 55 per cent.
Unless the benefit crystallisation event (BCE) is due to the payment of a death benefit, both you and your pension scheme administrator are jointly responsible for paying the tax charge. However the pension scheme administrator will normally do this.
Where the BCE is due to the payment of a death benefit only the person getting the benefit is responsible for paying the tax charge.
If you are liable to a lifetime allowance tax charge and you normally complete a Self Assessment tax return, then you should tell HMRC about your liability to the lifetime allowance charge as part of the return. Your pension scheme administrator should have already given you the information that you need to complete the relevant questions on the tax return.
If you use a paper return you will need to complete the relevant boxes on the additional information pages (SA101) of the return.
If you haven't completed a tax return before (or it has been a while since you did), you will need to complete a registration form to let HMRC know what has changed and to get a tax return - please follow the link below for more information.
Do you need to complete a tax return?
Yes, you will still need to complete a tax return. The return and helpsheets will guide you through the process of working out the pension savings from your pension schemes.
