If your retirement savings look like they could be nearing the Pension Lifetime Allowance, you might be wondering if there are ways to avoid paying the hefty LTA tax charges that are applied.
Currently, the lifetime allowance stands at £1,073,100. That is the total amount of savings that you can collect across all your pension pots without incurring a Lifetime Allowance tax charge. This limit is frozen until 2026 and applies to defined benefit and defined contribution pensions. Although the value of your pension for LTA purposes is calculated differently for defined contribution, as it is for final salary schemes. Your state pension is not included.
When Do You Pay Tax?
Taxes may be collected whenever there is a Benefit Crystallization Event, or BCE as they are better known. You will pay LTA taxes at this point if you are accessing funds over the LTA. There are also a number of automatic tests during a pension member’s lifetime. For example, there is an automatic test on your 75th birthday. An individual could have several BCEs. The BCE framework is designed to make sure that the lifetime allowance is applied to the total of an individual’s benefits across all registered pension schemes.
Here is a list of the different Benefit Crystallisation Events:
- BCE 1 – drawdown designation
- BCE 2 – scheme pension
- BCE 3 – scheme pension increases
- BCE 4 – annuity purchase
- BCE 5 – defined benefits at age 75
- BCE 5A – drawdown funds at age 75
- BCE 5B – money purchase at age 75
- BCE 5C – beneficiaries’ drawdown
- BCE 5D – beneficiaries’ annuity
- BCE 6 – relevant lump sums
- BCE 7 – lump sum death benefits
- BCE 8 – QROPS transfers
- BCE 9 – miscellaneous
BCE 9 is probably the least used. Here a set of regulations prescribes different circumstances in which it can apply. It covers very niche situations, such as certain payments made in error which are still authorised payments, and certain payments made after a person’s death. In each case there are very specific conditions to be met; a BCE 9 is not an everyday occurrence.
Once you reach the age of 75, there are no further tests against the LTA.
How is LTA Tax applied?
If you access a lump sum in excess of the Pension Lifetime Allowance, you can expect a tax bill of 55%. If you decide to leave the money in your pension and receive an income from it, there will be an LTA tax charge of 25%, as well as your marginal rate of income tax. Note that the LTA tax applied on QROPS transfers is 25%
Applying for protection – How to increase your personal Lifetime Pension Allowance
There are a number of ways you can look to increase your personal pension lifetime allowance, over and above the standard lifetime allowance.
Individual protection
Individual protection 2016 gives individuals a protected lifetime allowance equal to the value of their pension savings on 5 April 2016, subject to an overall maximum of £1.25 million. IP 2016 allows someone whose pension rights are valued over £1 million (the lifetime allowance between 6 April 2016 and 5 April 2018) to protect those rights, subject to an overall maximum of £1.25 million. For example, someone with pension rights worth £1.2 million at 5 April 2016 will be able to have £1.2 million as their personal lifetime allowance through IP 2016. This personalised lifetime allowance will not increase unless the lifetime allowance increases to a level greater than the individual’s personalised lifetime allowance.
Fixed protection
Fixed Protection can also provide a higher lifetime allowance than the standard LTA. You can still apply for fixed protection 2016 (there’s no deadline). Although previous versions are no longer available. Regardless of fund size or benefit value, you could apply for fixed protection as long as you don’t have Enhanced Protection, Primary Protection or an earlier version of Fixed Protection. Applications for FP2016 are made online (a Government Gateway account is required). If successful, FP2016 will apply retrospectively from 6 April 2016, regardless of when it’s granted. Fixed protection 2016 gives you a lifetime allowance of £1.25m. If the standard lifetime allowance increases above this level in the future, the fixed protection no longer applies and you can benefit from the higher standard lifetime allowance. However, Fixed Protection comes with a caveat – because it can automatically be lost. So FP16 will not be suitable for individuals who intend to continue to accrue benefits. Generally speaking, accruing any new pension savings will cause you to automatically lose fixed protection.
The Non-Resident Enhancement Factor
In addition, an alternative mechanism of protection, which is less well known. Is the opportunity for those individuals who were still benefiting from their UK scheme whilst non-UK resident, to apply for an Enhancement Factor, also known as a Non- Resident Factor. If you have spent time outside of the UK and contributed or received benefits during that time, you might be able to have your LTA increased, thus saving a lot of money on the related tax charges. There is no cap, and so it is possible for people with very long tenures overseas to get a large enhancement. Bear in mind though, that the tax-free cash available will still be based on the current standard LTA and not your enhanced amount. Sometimes depending on your position, a transfer can help you to possibly mitigate future LTA taxes.
To apply for LTA protection, you will need to log into your HMRC account and complete the relevant forms. You will need to be armed with information regarding the value of your combined pensions on different dates.
If you are unsure or need further advice, talking to a professional pension adviser could help to reduce your tax liability and help ensure you get the most out of your retirement fund.
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