April 2016 is set to bring a host of changes to the Lifetime Allowance (LTA), when the UK Government reduces this from £1.25m to £1m.
The rules provide that any excess over the new LTA will result in additional tax charges when a benefit crystallisation event occurs within a registered UK Pension Scheme (see detail below).
We detail below how Pension Schemes could potentially exceed the new LTA limit.
1.‘Defined Contribution’ (DC) or ‘Money Purchase’ Schemes
The value of the Pension fund is relevant to the LTA limit and will include any personal/employer contributions, plus any associated investment growth. If a client is a Member of more than one DC Scheme, then these have to be aggregated when performing the LTA calculation.
2. ‘Defined Benefit’ (DB) Schemes
These Schemes are based on salary as opposed to contributions and investment growth, and the amount has to be multiplied by a factor of 20 in order to calculate the capital equivalent value. These Schemes also usually pay a tax-free lump sum, and this also has to be included in the LTA calculation.
There is a series of benefit crystallisation events when a Pension Scheme is tested against the LTA. Full details of these can be found here
. However, the key factors are as follows:
- Retirement after age 55: Once a lump sum/income is taken from a Pension, these are tested against the LTA.
- At age 75: Any Pensions that have not been accessed will be tested against the LTA at this time. Pensions in drawdown will also be tested again at this time.
- Death pre-age 75: Pensions will be tested against the LTA to ensure that the limit has not been exceeded.
- Transfer to a QROPS: If a UK Pension Scheme funds are transferred into a QROPS, the value of the transferred funds are tested against the LTA.
If the LTA is exceeded, then the tax charge will depend on how the excess is paid from the Scheme.
- If as a lump sum: subject to a 55% tax charge.
- If as a Pension income: subject to a 25% tax charge.
- Transfer to a QROPS: subject to a 25% tax charge on the excess above the LTA.
Protecting against the LTA charges
The UK Government has confirmed that from April 2016, the following two protection regimes will be available allowing individuals a fixed or individual LTA, dependent on the value of their Pensions and/or the type of protection.
- Fixed protection 2016: This ‘fixes’ the LTA at the current £1.25 million. In order for this to apply, no further Pension benefits can be accrued in a Scheme on or after 6 April 2016.
- Individual protection 2016: The LTA will be set at the value of the Pension on 6 April 2016, when the new £1m LTA is introduced, so long as it is valued between £1m and £1.25m. This protection does allow further contributions, but any Pension in excess of the protected LTA will be taxed in the usual way when tested.
Transfer to QROPS: This currently enables an individual to safeguard their Pension fund against this tax charge and allows the fund to keep on growing. As detailed above, the fund is tested against the individual’s LTA at the point of transfer, rather than at the point of each benefit crystallisation event.
Please contact us if you would like more details about this potential area of LTA planning.
Future changes to LTA reported in the media
Recent UK press articles, such as in the Daily Mail
, claim that the Treasury is planning to slash the LTA even further – potentially as low as £750,000.
This is speculation at this stage, and therefore we would advise caution. Any new legislation remains subject to consultation, especially with the proposed Pensions Green paper and UK Budget in March 2016.