Adviser > Technical Central > Information & guidance > Pre A-Day protection > Lifetime allowance charge
Lifetime allowance charge
Anyone who has pension benefits with a value in excess of the lifetime allowance (LA) will be subject to a tax charge on their excess benefits value known as the lifetime allowance charge. This will apply not only to those who have pre 6 April 2006 (A-Day) pension benefits with a value in excess of the LA who haven't opted for suitable protection but also to those who build up benefits with a value in excess of the LA when they come to take benefits.
On 6 April 2102 the lifetime allowance reduced from £1.8 million to £1.5 million. However, the £1.8 million limit could have been retained on application to HMRC before 6 April 2012, though no further contributions can be made. This is called 'fixed protection'.
This analysis focuses on the main points to consider and provides a few examples of how this charge will apply.
Lifetime allowance charge (LAC)
The LA creates a ceiling on the benefits value that can be built up by members of registered pension schemes whilst continuing to benefit from tax relief. If the benefits value when they are taken exceeds the LA the difference between the two is subject to the LAC.
The LAC can be applied in either of two ways or a combination of both depending on how the excess benefits value above the LA is taken. The charge is:
- 55% if taken as a lump sum, or
- 25% if taken as income.
Members who decide to take their benefits in stages (more commonly referred to as phased retirement) will find that they will use up a proportion of the LA in force each time benefits are taken.
When somebody takes any of their benefits this is known as a ‘benefit crystallisation event'. Anyone taking their benefits either in full or in stages will have one or more crystallisation events. Let’s have a look at a few examples of how the LAC works in practice:
Excess benefits taken as cash
Joe reached his normal retirement date on the 6 April 2012 and had a benefits value of £2.5 million. If he had taken all of his benefits (including benefits above the LA as cash), he had not protected his benefits value and had a tax-free lump sum (TFC) entitlement of 25% of the benefits value, the LAC would have been as follows:
| Benefits value at crystallisation date (6 April 2012) | £2,500,000 |
| LA | £1,500,000 |
| Excess benefits value | £1,000,000 |
| Less LAC (£1,000,000 x 55%) | £ 550,000 |
| Net excess benefits value | £ 450,000 |
| Benefits taken: | |
| TFC * (£1,500,000 x 25%) | £ 375,000 |
| Net excess benefits value | £ 450,000 |
| Total lump sum | £ 825,000 |
| Plus remaining benefits value for income (£1,500,000 - £375,000) | £1,125,000 |
*TFC is the lesser of:
- 25% of the benefits value at crystallisation (£2,500,000 x 25% = £625,000), and
- 25% of the LA at crystallisation (£1,500,000 x 25% = £375,000).
In this example Joe received a total lump sum of £825,000 with his remaining benefits value of £1.125 million being used to purchase an income. A LAC of £550,000 was paid.
Excess benefits taken as income
Frank reached his normal retirement date on the 6 April 2012 and had a benefits value of £2 million. If he had taken all his benefits (including benefits above the LA as income), he had not protected his benefits and had a TFC of entitlement of 25% of the benefits value, the LAC that would have applied is as follows:
| Benefits value at crystallisation date (6 April 2012) | £2,000,000 |
| LA | £1,500,000 |
| Excess benefits value | £ 500,000 |
| Less LAC (£500,000 x 25%) | £ 125,000 |
| Net excess benefits value | £ 375,000 |
| Benefits taken: | |
| TFC * (£1,500,000 x 25%) | £ 375,000 |
| Plus residual benefits value for income (£1,500,000 - £375,000) | £1,125,000 |
| Plus net excess benefits value | £ 375,000 |
| Total benefits value to provide income | £1,500,000 |
*TFC is the lesser of:
- 25% of the benefits value at crystallisation (£2,000,000 x 25% = £500,000), and
- 25% of the LA at crystallisation (£1,500,000 x 25% = £375,000).
In this example Frank received a total lump sum of £375,000 with his remaining benefits value of £1.5 million being used to purchase an income. A LAC of £125,000 was paid.
It's worth noting that the effective rate of tax is the same i.e. 55% regardless of how the excess benefits value is taken - either cash or income - as it's assumed that the recipient is a higher rate taxpayer. This is explained below:
| Benefits value in excess of LA | £ 500,000 |
| LAC (£500,000 x 25%) | £ 125,000 |
| Net benefits value | £ 375,000 |
| Higher rate tax on net benefits value (£375,000 x 40%) | £ 150,000 |
| Total tax paid (£125,000 + £150,000) | £ 275,000 |
| Effective rate of tax on excess benefits value (£275,000/£500,000) | 55% |
Phased retirement
Emma was 57 on the 6 April 2010 and had a benefits value of £3 million. Assuming that she takes her benefits in two stages - 6 April 2010 and 6 April 2014 – she had not applied for primary or enhanced protection and had a TFC entitlement of 25% of the benefits value, the LAC that would apply on her excess benefits value would be as follows:
On 6 April 2010 Emma decided to take £500,000 of her benefits value - 25% as TFC with the balance used to provide an income.
| Benefits value at 1st crystallisation event (6 April 2010) | £3,000,000 |
| LA | £1,800,000 |
| Amount of benefits value required (crystallised) | £ 500,000 |
| LAC applied | £ 0 |
| Benefits taken: | |
| TFC * (£500,000 x 25%) | £ 125,000 |
| Plus residual benefits value as income (£500,000 - £125,000) | £ 375,000 |
- 25% of the benefits value at crystallisation (£500,000 x 25% = £125,000), and
- 25% of the LA at crystallisation (£1,800,000 x 25% = £450,000)
In this example Emma received a total lump sum of £125,000 with her remaining benefits value of £375,000 being used to purchase an income. No LAC is payable at this time.
On the 6 April 2012 the lifetime allowance reduced from £1.8 million to £1.5 million. As she had not applied for primary or enhanced protection Emma had the option to apply for fixed protection. This would let her keep the £1.8 million lifetime allowance, although there are conditions that apply. Emma would not be allowed to:
- accrue more benefits in any pension plan, e.g. pay more contributions to a money purchase plan or accrue more benefits under a defined benefit arrangement
- start a new plan unless it is set up to accept a transfer value
- transfer benefits anywhere other than to a registered pension scheme or to a qualifying recognised overseas pension scheme.
At the 1st crystallisation event Emma used up £500,000 of her benefits value to provide retirement benefits. This was 27.78% of the lifetime allowance at the time (£1.8 million).
The remaining 72.22% is applied to the LA in force at the 2nd crystallisation event before calculating the excess benefits value that any lifetime allowance charge would apply to. This process is repeated each time benefits are taken until the whole benefits value is used up.
So, if Emma decides to apply for fixed protection and to take her remaining benefits (including her excess benefits value as cash) on the 6 April 2014 having already used up £500,000 of the LA the LAC that will apply is as follows:
| Benefits value at 2nd crystallisation date (6 April 2014) | £2,650,000 |
| LA | £1,800,000 |
| Amount crystallised | £2,650,000 |
| LA remaining – [£1,800,000 - 72.22%] | £1,299,960 |
| Excess benefits value | £1,350,040 |
| LAC (£1,350,040 x 55%) | £ 742,522 |
| Net excess benefits value | £ 607,518 |
| Benefits taken: | |
| TFC * [(£1,800,000 x 72.22%) x 25%] | £ 324,990 |
| Net excess benefits value | £ 607,518 |
| Total lump sum | £ 932,508 |
| Plus residual benefits value for income | £ 974,970 |
*TFC is the lesser of:
- 25% of the benefits value at crystallisation (£2,650,000 x 25% = £662,500), and
- 25% of the available portion of the LA at crystallisation [(£1,800,000 x 72.22%)) x 25% = £324,990]
In this example Emma receives a total lump sum of £932,508 with her remaining benefits value of £974,970 being used to purchase an income. A LAC of £742,522 is paid.
If Emma did not apply for fixed protection and takes her remaining benefits (including her excess benefits value as cash) on the 6 April 2014 having already used up £500,000 of the LA the LAC that will apply is as follows:
| Benefits value at 2nd crystallisation date (6 April 2014) | £2,650,000 |
| LA | £1,500,000 |
| Amount crystallised | £2,650,000 |
| LA remaining – [£1,500,000 x 72.22%] | £1,083,300 |
| Excess benefits value | £1,566,700 |
| LAC (£1,566,700 x 55%) | £ 861,685 |
| Net excess benefits value | £ 705,015 |
| Benefits taken: | |
| TCF * [(£1,500,000 x 72.22%) x 25%] | £ 270,825 |
| Net excess benefits value | £ 705,015 |
| Total lump sum | £ 975,840 |
| Plus residual benefits value for income | £ 812,475 |
*TFC is the lesser of:
- 25% of the benefits value at crystallisation (£2,650,000 x 25% = £662,500), and
- 25% of the available portion of the LA at crystallisation [(£1,500,000 x 72.22%) x 25% = £270,825]
In this example Emma receives a total lump sum of £975,840 with her remaining benefits value of £812,475 being used to purchase an income. A LAC of £812,475 is paid.
All references to taxation are based on our understanding of current taxation law and practice and may be affected by future changes in legislation and the individual circumstances of the investor.
In addition, the information provided is based on our current understanding of the relevant legislation and regulations and may be subject to alteration as a result of changes in legislation or practice.
Published 14 October 2004
Updated 29 March 2012
For professional advisers only
