An update on the increase in the lifetime allowance
This communication is for intermediaries only. It mustn’t be distributed to, or relied on by, customers.
The standard lifetime allowance (SLA) sets a limit on the amount of pension benefits that can be paid to or in respect of an individual, by way of lump sums or retirement income, without triggering an additional tax charge.
The base-level SLA has increased on an annual basis since 6 April 2018 in line with the percentage increase (if any) in the Consumer Prices Index (CPI) over the year ending in the September immediately before the beginning of the tax year in question, with an element of rounding up. Based on the 1.7% increase in CPI in the year to September 2019, the SLA increased to £1,073,100 on 6 April 2020. Increases in the SLA are formally announced by the chancellor in a Budget and a statutory instrument is issued to bring it into force from the start of the new tax year.
While the yearly increases may appear to be token amounts, any rise to the base-level SLA should be welcomed after a series of reductions from April 2012, and complex transitional rules introduced each time to protect existing benefits. Even a small increase provides a number of advice issues that should be discussed with clients who may be affected. Take a look at the following examples:
With seven different forms of SLA protection currently in existence, it’s easy to see why there’s confusion. It’s vital to have a clear understanding of the rules applying as the risks of not registering for protection when eligible, or in losing existing protection, can be very serious. This fund protection summary table attempts to summarise, compare and contrast the main features of the full range of protections available since 6 April 2006.
The HMRC look-up service for scheme administrators means that clients claiming to have one or more of the protections will be asked to supply details of their protection notification number, and scheme administrator reference, at the point of benefit crystallisation (or earlier), to allow scheme administrators to check their current protection status.
Not yet registered for Fixed protection 2016 (FP16) or Individual protection 2016 (IP16)
With no registration deadline for FP16 or IP16 it’s not too late for clients to apply for protection. If eligible, registration can be done online.
As a reminder, FP16 protects an SLA of £1.25 million. This protection is available regardless of the level of pension savings held on 5 April 2016 or currently. Any contributions paid to a defined contribution scheme, or any benefit accrual in a defined benefit or cash balance arrangement, on or after 6 April 2016 means that FP16 isn’t available (some other protections are also affected by similar conditions).
IP16 protects an amount equal to the actual value of their pension savings held on 5 April 2016 subject to a ceiling of £1.25 million. This protection is only available if the total value of pension savings held at 5 April 2016 exceeded £1 million and it can be applied for instead of, or in addition to, some other protections. If the value of their pension savings on 5 April 2016 didn’t exceed the current base-level SLA (or has since been overtaken by it) – then it’s no longer appropriate to register for IP16.
Already FP16 or IP16 registered
Those who have already registered for FP16 are unlikely to be affected by the increases in the short term, not until such time as the cumulative yearly increases take the base-level SLA above £1.25 million.
Those with existing IP16 may be affected if their own protected amount is overtaken by the new base-level SLA. Anyone with an existing IP16 protected amount equal to or less than this amount would see their protection fall away and instead rely on the base-level SLA.
Timing of benefits
Clients who intend to take benefits towards the end of a tax year, and who may be affected by the SLA now or in the future, may wish to hold off taking benefits until after 5 April when any increase to the SLA takes effect. This is when any benefit crystallisation will use up a lower percentage of the available SLA than it would if taken before then. This may mean a possible tax charge is reduced or avoided in future.
Pension commencement lump sums (PCLS)
For some clients, delaying taking benefits until after 5 April may potentially mean that a higher tax-free lump sum is available, as the maximum 25% PCLS will apply against any higher base level SLA applying from the start of the new tax year.
For others, an increase in the base level SLA may see their overall PCLS fall. For example, those who have a scheme-specific PCLS use a special formula to calculate their overall PCLS that includes an amount attributed to the ‘post-5 April 2006’ fund. The formula uses the movement in the base-level SLA to place a current value on the fund at 5 April 2006 to subtract from the final fund. An increase in the base-level SLA will mean a smaller post-5 April 2006 fund and therefore a smaller PCLS overall. Clients who may be affected will need help to work out if it’s advisable to take their PCLS before the start of the new tax year – if eligible to do so.
Lifetime allowance already exhausted
Those who have crystallised their pension benefits and have already exhausted their full SLA will be unaffected by further increases in the base-level SLA. If they’ve zero percent remaining, it doesn’t matter what level the base-level SLA grows to in future (unless more fundamental changes to the pension rules are made). Having said that, many of these clients will still need help in taking any remaining pension benefits in the most tax efficient manner, protecting their overall wealth and inheritance tax planning.
Over lifetime allowance regardless
For those with uncrystallised pension funds that will inevitably be over their SLA at some point regardless of annual increases in the base level – there are a number of different strategies available to mitigate the SLA charge. Clients that are currently able to take benefits will want to know if they should crystallise benefits now and pay the SLA charge up front or delay this until later – possibly as late as age 75. If benefits are to be taken now, clients will need to know if it’s in their best interests to take any amounts over the SLA by way of a lump sum or taxable income.
Clients also need to remember that if they die before age 75 the value of their uncrystallised funds will be tested against their available SLA and that tax charges will apply to their beneficiaries on any excess benefits depending on how they’re taken.
There may be an opportunity for the beneficiaries to take benefits from any uncrystallised funds that are over the SLA as income rather than lump sum in order to reduce the overall tax payable. Also, for those who are or might be affected by the SLA – there could be an opportunity to consider other methods of providing life cover outside of the registered pension scheme environment. For example, under the relevant life provisions, for maximum tax efficiency.
The information in this article is based on our understanding of current taxation law and HM Revenue and Customs (HMRC) practice, which may change. The tax treatment depends on the individual circumstances of each client and may be subject to change in future.