Pensions Technical case study: Multiple BCEs and testing against the lifetime allowance

This article is for financial advisers only. It must not be distributed to, or relied on by, customers. It is based on our understanding of legislation at the date of publication.

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About Margaret

  • Margaret is 71 years old
  • She has an annuity which has been in payment since 2001
  • She uses pension funds to buy an annuity in 2016
  • She also two uncrystallised Personal Pensions (PP1 & PP2)
  • Margaret doesn’t have any lifetime allowance protection or tax-free cash protection

Margaret was aged 51 in 2001 when she took tax-free cash and purchased an annuity from one of her pensions. In May 2016, she took tax-free cash and purchased an annuity from another one of her pensions. This coincided with cutting her hours at ABC Engineering Ltd with an aim to stopping work completely in 2021.

Margaret’s financial adviser wants to know how her remaining benefits will be tested against the standard lifetime allowance (SLA) and what happens at age 75.

The first benefit crystallisation events (BCEs)

Margaret’s first BCEs were in May 2016 when she crystallised a £500,000 pension fund – she took tax-free cash of £125,000 and used the remaining £375,000 to purchase an annuity.

At this first BCE, the benefits she had taken before 6 April 2006 (the date BCEs were introduced) needed to be taken into account against the lifetime allowance. This is referred to as a ‘deemed BCE’ and is done immediately before the first BCE on or after 6 April 2006. This reduced her available lifetime allowance for her first actual BCE in May 2016.

In 2001, her annuity started at £1,250 per annum and by May 2016 it had increased to £1,500 per annum.

For the purpose of measuring against the lifetime allowance, the value of the annuity purchased in 2001, would have been calculated as:

25 x annual amount of annuity being paid at the time of valuation (i.e. May 2016)

25 x £1,500

= £37,500

The SLA was £1m in May 2016 so, after allowing for the SLA used up by the annuity purchased in 2001, Margaret had £962,500 of the SLA left.

The £500,000 she was taking in 2016 would have been tested against her remaining lifetime allowance using BCE6 (for the £125,000 tax-free cash) and BCE4 (for the £375,000 being used to purchase an annuity). She had then used up a total of £537,500 of the SLA.

Margaret will have received a statement from the scheme administrator, telling her how much lifetime allowance had been used up by the two BCEs. This is calculated by:

Amount crystallised by BCE/SLA x 100/1

= £500,000/£1m x 100/1

= 50%

The scheme administrator must also provide a statement for the deemed BCE within 3 months of the first actual BCE.

This would be calculated as:

Amount crystallised by BCE/SLA x 100/1

= £37,500/£1m x 100/1

= 3.75%

It’s worth noting that the percentages expressed on these statements have been rounded down to two decimal places.

Margaret used up 53.75% of her lifetime allowance on her first BCEs.

Subsequent BCEs

We’re now in the 2021/22 tax year and the lifetime allowance is £1,073,100. Margaret has decided to stop working and wants to take one of her remaining personal pensions (PP1) as an Uncrystallised Funds Pension Lump Sum (UFPLS) as she wants cash to move house and buy a new car. She also wishes to take the tax-free cash from her other personal pension (PP2) and put the remainder into drawdown so she can draw income as and when she needs it.

PP1 and PP2 are with the same provider and Margaret wishes to take these benefits at the same time. They are worth £310,000 and £200,000 respectively.

As the BCEs will occur at the same time, it’s up to Margaret to decide the order that the BCEs take for the purpose of the lifetime allowance test. This is important for Margaret as the lifetime allowance is going to be exceeded.

Margaret decides to take PP1 first. The benefits are tested against BCE6.

Amount crystallised by BCE/SLA x 100/1

= £310,000/£1,073,100 x 100/1

= 28.88% (rounded down to two decimal places)

She has now used up 82.63% of her lifetime allowance and has 17.37% left.

PP2 is then tested against the remaining lifetime allowance. She wishes to take her maximum tax-free cash. Her maximum tax-free cash is limited to 25% of her remaining lifetime allowance where this is less than 25% of her remaining funds.

This means her maximum tax-free cash is 25% of the remaining lifetime allowance. This is calculated as:

£1,073,100 x 17.37% = £186,397.47

£186,397.47 x 25% = £46,599.37

As BCE 6 is always treated as occurring immediately before the BCE for the associated pension benefit (i.e. BCE 1, 2 or 4), this is tested against the lifetime allowance first.

So,

£46,599.37/£1,073,100 x 100/1

= 4.34% (rounded down to two decimal places)

Margaret has now used up 86.97% of her standard lifetime allowance.

Then BCE 1 occurs:

£200,000 - £46,599.37 - £153,400.63 left to go into drawdown

She has 13.03% of her SLA left so £139,824.93 (£1,073,100 x 13.03%) can be taken before a lifetime allowance charge will apply.

Margaret decides to put the £13,575.70, the excess over the lifetime allowance, into drawdown too so she will be subject to tax of £3,393.93 (25% x £13,575.70).

This means a total of £150,006.70 (£139,824.93 + (£13,575.70 - £3,393.93)) is put into drawdown.

Reaching age 75

So what happens when Margaret reaches age 75? Although she has no uncrystallised funds left, her funds in drawdown will be tested again at age 75 under BCE 5a.

Let’s assume her drawdown funds will be worth £152,500 at age 75. You then take away the amounts previously crystallised under BCE 1 from the total value of the drawdown funds at age 75 (known as the overlap).

=£152,500 - £150,006.70

= £2,493.30

As Margaret has no lifetime allowance remaining, the £2,493.30 will be subject to a lifetime allowance charge. The calculation will be:

£2,493.30 x 25% = £623.33

It’s worth noting that any withdrawals that Margaret may have taken from the drawdown fund will not have been added back in to the value of the drawdown fund. This means taking withdrawals can help reduce or eliminate any further liability to the lifetime allowance charge. Remember, however, any withdrawals will be taxed at the member’s marginal rate of tax.

We have FAQs on BCEs and valuing benefits against the lifetime allowance in the ‘Retirement benefits’ section of the Technical Zone on the Aegon website.

Pensions Technical Services