Who wants to be a millionaire?
This article provides an example showing how the Lifetime Allowance (LTA) for pensions savings would affect someone who is about to retire with pension benefits just over £1,073,100. Useful reading for those studying for any of the CII J05, R04, AF7 or AF8 units.
This article is relevant to examinable tax year 2021/22.
For someone who, over the years, has paid steady pension contributions perhaps along with the help of their employer, becoming a millionaire might just become a reality. The current pension lifetime allowance stands at just over a million at £1,073,100 and breaching the limit has serious tax implications. The allowance was set to increase annually at CPI but the government announced in the 2021 budget they are freezing the limit for 5 years and therefore, as time goes by more and more people, not just those who are particularly wealthy, may face a hefty tax charge.
What happens when pension benefits exceed the LTA?
When pension benefits become payable they are tested against the lifetime allowance (LTA). Let’s look at an example of someone who is just about to retire:
Dave will be retiring in March and will be taking the benefits from his defined benefit scheme. He is looking forward to a scheme pension of £48,000 plus a pension commencement lump sum of £200,000.
Entitlement to a scheme pension triggers benefit crystallisation event 2 (BCE2) and taking a lump sum triggers BCE6. BCE6 will always be deemed to have occurred first.
The scheme pension is multiplied by 20 to get a notional capital value (this equates to a 5% annuity rate) and added to the lump sum of £200,000. £48,000 x 20 = £960,000 + £200,000 = £1,160,000.
The value of Dave’s pension benefits is more than the LTA, so the excess over £1,073,100 is subject to a LTA charge which has to be paid before benefits can be paid.
If Dave takes the excess of £86,900 as a lump sum, it will be subject to a 55% charge; £86,900 x 55% = £47,795. If he chooses to take the excess as an income, it will be subject to a 25% LTA charge of £21,725. This is deducted first and the remainder retained to provide an income, which will also be subject to income tax at Dave’s marginal rate.
Here is an example of how Lifetime Allowance affects a retiree with pension benefits over £1,073,100 Share on X
Who is liable for paying the charge?
The liability for paying the charge falls on the scheme administrator and Dave; although, usually the scheme administrator would deduct the tax charge before a payment is made and send Dave notification.
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