On the surface the Lifetime Allowance can seem complicated to understand. To help de-mystify some of the technical phraseology surrounding Lifetime Allowance, Menzies Wealth Management (MWM) have created a jargon busting reference guide.
What is the Lifetime allowance?
The Lifetime Allowance is a limit on the total amount of Pension Income and Tax Free Cash that you can draw from your pension savings. You will be subject to a tax charge known as the Lifetime Allowance Charge if your benefits exceed the Lifetime Allowance.
The Lifetime Allowance Charge is levied at 55% where you take the excess benefits as a lump sum; or 25% where you take the excess as pension income. However, in either scenario the net effect upon you is intended to be the same (as pension income is also subject to income tax at your marginal rates).
The current Lifetime Allowance is £1.25 million but from 6th April 2016 this will fall to £1million.
The Government has provided two forms of LTA Protection, “Fixed Protection 2016” & “Individual Protection 2016” which we will discuss later this week.
Lifetime Allowance – Defined Contribution Pension Schemes
Under a “defined contribution” pension arrangement, you and / or your employer pay a specified (i.e. defined) amount into your pension. Your retirement benefits are thus dependant upon a combination of factors including how much has been paid into your pension, tax relief received, investment growth & annuity rates.
“Personal Pensions” and “SIPPS” are two common examples of Defined Contribution pension arrangements. A lifetime allowance of £1million may sound like a lot of money but let’s set a little context by considering what benefits a £1million pension fund might provide to a 65 year old man. Let us assume that he takes 25% tax free cash (£250,000) and purchases an annuity using the remaining £750,000. This would provide a level pension of £35,000 per annum, before tax.
If he opted for an annuity which increased in payment by 5% per annum then his starting income might be closer to £20,000 per annum.
When considered in these terms, a £1million Lifetime Allowance sounds a little less generous.
Lifetime Allowance – Defined Benefit Pension Schemes
A defined benefit pension scheme is sometimes referred to as a “final salary” pension. For those lucky enough to have a valuable Defined Benefit pension, the calculation for the Lifetime Allowance test is more complex. This is because we have to “capitalise” the pension income by applying a conversion factor. As an example, let us consider a member of a Defined Benefit Scheme who is retiring with a pension income of £50,000 per annum.
For the Lifetime Allowance Test, the value of the pension benefits will be £1,000,000 (£50,000 x 20 conversion factor). If the individual also received Tax Free Cash in addition to the pension then this would also need to be included within the Lifetime Allowance Test.
Many members of Defined Benefit Pension Schemes also have Defined Contribution schemes and these will also be tested against the lifetime allowance when taking benefits.
For example NHS Consultants often have a personal pension in respect of their private work in addition to their membership of the NHS Pension Scheme.
When considered in these terms, a £1million Lifetime Allowance begins to sound distinctly less generous.
Lifetime Allowance Protection – Fixed Protection
The Fixed Protection 2016 (FP16) provides for a protected lifetime allowance of £1.25million.
There is no requirement for a minimum fund value and unlike previous forms of fixed protection there is no application deadline. However the online application process is not expected to be available until July 2016.
It is important to understand that FP16 was lost from 6th April 2016 if you make pension payments to a Defined Contribution arrangement or if you receive “accrual” under a Defined Benefit Arrangement in excess of an allowable amount.
In simple terms “accrual” means an increase in the value of the benefits promised to you.
Whilst it is likely that active membership of a Defined Benefit arrangement would result in the loss of FP16, we urge extreme caution if you are considering ceasing your active membership of a Defined Benefit arrangement as this is likely to result in the loss of very valuable pension benefits. An Independent Financial Adviser will be able to consider your circumstances and advise you as to the appropriate course of action.
For clarity, FP16 is not available if you already hold an existing form of protection.
Lifetime Allowance Protection – Individual Protection
The Individual Protection 2016 (IP16) provides for a “Personalised Lifetime Allowance” up to £1.25million.
As per Fixed Protection 2016 (FP16) there is no application deadline but the online application process is not expected to be available until July 2016. However, unlike FP16, IP16 will not be lost if you make contributions to a Defined Contribution arrangement or if you receive “accrual” under a Defined Benefit Arrangement after 5th April 2016.
IP16 is only relevant where the value of your benefits as at 5th April 2016 is above £1million. As an example, if your benefits (whether Defined Contribution, Defined Benefit or a combination of both) equated to a valuation of £1.15million on 5th April 2016, then your Personalised Lifetime Allowance would be £1.15 million.
Your maximum Personalised Lifetime Allowance
If your benefits were valued at £1.5million, you would be limited to the maximum Personalised Lifetime Allowance of £1.25million.
If however your benefits were valued at £900,000 then you would not be eligible for IP16.
Finally, an individual is allowed to hold both IP16 and FP16 concurrently, albeit the specific rules for both would need to be met in order to maintain each protection.
Menzies Wealth Management (MWM)
Menzies Wealth Management is a subsidiary company of the Menzies Group, providing independent financial advice to both private and corporate clients. We are independent of all financial institutions.
Menzies Wealth Management Limited (“the Company”) is authorised and regulated by the Financial Conduct Authority (FRN 486548). The Company is registered in England and Wales, number 06597008, and has its registered office at 1st Floor, Midas House, Goldsworth Road, Woking, Surrey GU21 6LQ.