Pensions Technical Case study: 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.

About Daniel

  • Daniel is 56 years old
  • He has an Aegon Retirement Choices SIPP 
  • He has fixed protection 2016 (FP2016), which means his standard lifetime allowance (SLA) is fixed at £1.25m
  • Daniel doesn’t have scheme-specific tax-free cash protection

Daniel’s SIPP with Aegon has a current fund value of £1.75m, which is all uncrystallised, and he doesn’t have any other private pensions.  He hasn’t previously taken benefits from any other registered pension schemes.  As the current value of Daniel’s fund is well above his SLA of £1.25m (the protected amount), he can expect to pay a lifetime allowance charge (LAC) when he takes benefits in excess of that amount. 

Daniel’s financial adviser wants to know the options available to his client, in terms of crystallising either some or all of his benefits now, and what would happen if he died before taking any benefits.  His adviser has asked us how the lifetime allowance charge would apply in each scenario.


Take all benefits now

If Daniel decides to take all of the benefits from his SIPP now, they’ll be tested against his SLA of £1.25m, which he has as a result of holding FP2016, not the SLA that applies in the current tax year.  Following the crystallisation, Aegon would provide Daniel with a benefit crystallisation event (BCE) statement indicating that 100% of his SLA had been used up.

Daniel would incur an LAC on the excess amount over his SLA, ie £1,750,000 - £1,250,000 = £500,000.  The LAC rate would be:

Lump sum

55% if the excess is taken as a lump sum, known as a ‘lifetime allowance excess lump sum’

£500,000 x 55% = £275,000 (paid to HMRC as a tax charge)

Income

25% if the excess is taken as income, with the income itself taxed at Daniel’s marginal rate of income tax

£500,000 x 25% = £125,000 (paid to HMRC as a tax charge)

Lump sum & income

A combination of the two rates if both a lump sum and income benefits are paid from the excess funds

Example –
Lump sum of £300,000 x 55% = £165,000, plus
Income of £200,000 x 25% = £50,000
Total LAC = £215,000 (paid to HMRC as a tax charge)

Aegon would deduct the LAC from the excess funds at the point of crystallisation, and it would report and pay the tax charge direct to HMRC through its quarterly Accounting for Tax return.

Daniel would need to also report the tax charge to HMRC through his Self-assessment tax return, showing the total amount of LAC due and the amount that Aegon is paying direct to HMRC. 

Note, Aegon and Daniel would have joint and several liability to pay the LAC, but in practice Aegon would deduct the tax charge before paying any excess benefits to Daniel and pay the LAC direct to HMRC. 

The maximum tax-free cash available to Daniel would be limited to the lower of:

  • 25% of the funds being crystallised at the time, ie £1.75m x 25% = £437,500, and
  • 25% of Daniel’s SLA of £1.25m, ie £1.25m x 25% = £312,500.

Therefore, Daniel would be able to take up to £312,500 as a tax-fee lump sum, with the balance of his funds (less the LAC) being available to provide an income, either flexi-access drawdown or an annuity.


Take benefits up to Daniel’s lifetime allowance

Daniel could crystallise up to his SLA of £1.25m now and wait to see whether future legislation increases the amount of the LTA (other than the current planned Consumer Price Index increases), changes how the LAC rules work or even removes the LAC altogether.  By doing this, he will defer any potential LAC to some point in the future.  Aegon would still carry out a test against Daniel’s lifetime allowance now, and would give him a BCE statement confirming the percentage of his SLA used up. 

If Daniel decides to only crystallise funds equal to his £1.25m SLA now, there’s no LAC at this point in time and it will be deferred until he takes any further benefits.  If he doesn’t crystallise any further benefits, a lifetime allowance test would be carried out when he reaches age 75.  The BCE would be BCE 5A for any remaining flexi-access drawdown funds at that time, or BCE 5B for any remaining uncrystallised funds.  In both cases, it would be the value of those funds on Daniel’s 75th birthday that would be tested against his available SLA. 

Given that he’d already used up 100% of his SLA, an LAC would arise in relation to these remaining funds.  Aegon would deduct this LAC from his remaining funds and pay it direct to HMRC, even if he didn’t actually take any benefits on reaching age 75.

Daniel could reduce the amount of any LAC arising at age 75 by taking income from his flexi-access drawdown funds before reaching age 75.  This would reduce the value of the funds that would be tested against his SLA under BCE 5A, which effectively tests the ‘growth’ in the drawdown funds since they were first designated.  However, Daniel would pay income tax at his highest marginal rate on the income that was withdrawn.

It’s worth noting that if Daniel uses up 100% of his £1.25m SLA now, the way the current tax rules work he wouldn’t benefit from any future increases in the SLA.  This is because he wouldn’t have any of his own SLA remaining on any subsequent BCEs. 


Take no benefits now - what happens on death?

Let’s say Daniel decides not to take any benefits from his SIPP now, and he dies before reaching age 75 with uncrystallised pension rights.  Following its discretionary disposal process, and taking into account that Daniel had completed a death benefit nomination form in favour of his wife Jill before his death, Aegon decides that Jill should be Daniel’s sole beneficiary.  Under the Aegon SIPP scheme rules, Jill can choose from the following death benefit options, or choose a combination of them:

Benefit type Tax position
Lump sum - known as an ‘uncrystallised funds lump sum death benefit’ An amount up to Daniel’s SLA of £1.25m could be paid tax-free as a lump sum to Jill, provided it’s paid within two years of the date Aegon were first notified of Daniel’s death or, if earlier, the date Aegon could first reasonably have been expected to know of his death.
Beneficiary’s flexi-access drawdown An amount up to Daniel’s SLA of £1.25m could be put into a flexi-access drawdown arrangement in Jill’s name. She could choose when and how to take income from the fund with any drawdown income being paid tax-free to her, provided she designates it into beneficiary’s flexi-access drawdown within two years of the date Aegon were first notified of Daniel’s death or, if earlier, the date Aegon could first reasonably have been expected to know of his death.
Beneficiary’s annuity Up to Daniel’s SLA of £1.25m could be paid put into an annuity contract in Jill’s name. The annuity payments would be paid tax-free to Jill, provided the contract is purchased within two years of the date Aegon were first notified of Daniel’s death or, if earlier, the date Aegon could first reasonably have been expected to know if his death.

Note, not all of the above options would be available from non-platform Aegon pension  products.

The fund in excess of Daniel’s SLA of £1.25m would be subject to an LAC of 55% (provided the death benefit was paid/designated/purchased within the relevant two year period mentioned above). 

Aegon would pay the full fund value as a death benefit to Jill as the beneficiary.  Daniel’s personal representatives would be responsible for carrying out the lifetime allowance test (this would be BCE 7 if paid as a lump sum, BCE 5C if paid as drawdown or BCE 5D if paid as an annuity), identifying the amount chargeable to the LAC, and also reporting this to HMRC.  HMRC would then get in touch with Jill, as the recipient of the death benefit, and it would be her responsibility to pay the LAC direct to HMRC.

Note, if any of the above three options don’t take place before the end of the relevant two year period, there is no test against Daniel’s SLA.  Instead, the lump sum or income will be taxed at Jill’s marginal rate of income tax.

If Daniel died after reaching age 75 but hadn’t taken any benefits from his Aegon SIPP, the same options mentioned above would be available to Jill.  However, the amount up to Daniel’s SLA of £1.25m would be taxed at Jill’s marginal rate of income tax instead of being tax-free.  If Aegon paid the death benefit as a lump sum, it’s unlikely to know Jill’s tax code and would have to deduct the income tax using an emergency tax code.  This normally results in too much tax being deducted initially, but Jill should be able to reclaim it by contacting HMRC direct.  


Further information

We have an FAQ on the lifetime allowance in the ‘Retirement benefits’ section of the Technical Zone on the Aegon website.

Pensions Technical Services