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Pensions Tax Manual

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The lifetime allowance and the lifetime allowance charge: lifetime allowance excess lump sum

Glossary PTM000001
   

 

Payment of a lifetime allowance excess lump sum 
Nature of the lifetime allowance excess lump sum 
Transfer to a qualifying recognised overseas pension scheme 
Order of BCEs where a chargeable amount is going to arise 
Amount of lifetime allowance excess lump sum 
Example showing the calculation of the chargeable amount 
Taxation of a lifetime allowance excess lump sum

Section 216(1) BCE 6 Finance Act 2004

Paragraph 15 Schedule 32 Finance Act 2004

Paragraph 11 Schedule 29 Finance Act 2004

Payment of a lifetime allowance excess lump sum

Where a member’s lifetime allowance has been fully used up, any benefit entitlement crystallising over and above the member’s available lifetime allowance may, if the scheme permits, and the member is under age 75, be commuted and paid entirely as a lump sum payment.

Where the member’s available lifetime allowance has been fully used up and excess funds or rights are commuted in this way, the resulting lump sum payment is called a lifetime allowance excess lump sum.

A higher tax charge is imposed on any benefits crystallising as a lump sum once the lifetime allowance has been exhausted (55 per cent, compared to 25 per cent where the chargeable amount is being retained in the scheme). This higher rate is designed to cancel out any reliefs obtained in the accrual of those pension benefits which are now paid as a lump sum, to compensate for the loss of tax on what would otherwise have been the provision of a future pension benefit to a member.

Where, following liaison with the member before a benefit crystallisation event (BCE), a potential chargeable amount is identified, the scheme administrator will calculate the level of pension/lump sum entitlement that will take the member up to their lifetime allowance, without creating a chargeable amount. Depending on the scheme’s rules, the scheme administrator may then give the member the option of commuting the excess pension entitlement remaining to a lump sum payment (a lifetime allowance excess lump sum). The lifetime allowance excess lump sum paid will then crystallise through BCE 6, giving rise to a chargeable amount.

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Nature of the lifetime allowance excess lump sum

A lifetime allowance excess lump sum is a lump sum that:

  • is not a short service refund lump sum or a refund of excess contributions lump sum, as all these lump sum payments can be paid where there is no available lifetime allowance and their payment is not tested for lifetime allowance purposes through BCE 6
  • does not reduce the rate of payment of any pension to which the member has already become (actually) entitled, or extinguish the member’s entitlement to payment of such pension (so this means any pension in payment already under the scheme). But this requirement does not prevent an uncrystallised pension entitlement coming into payment at the same time from being reduced; and indeed this will normally occur under a defined benefits arrangement for the chargeable amount to be wholly paid as a lifetime allowance excess lump sum
  • is paid when the member has reached normal minimum pension age (or earlier where the ill-health condition is met or the member has a protected pension age). (This must always be the case, as the only times when a BCE for lifetime allowance purposes can arise earlier than this are where a transfer overseas occurs or where the member has died and there are either relevant unused uncrystallised funds designated for dependants’ or nominees’ flexi-access drawdown pension or, if the member died after 2 December 2014, a dependants’ or nominees annuity is purchased using relevant unused uncrystallised funds, and in each case no lump sum is paid - see below), and
  • is paid before the member reaches the age of 75. At age 75 all the member’s benefits will have crystallised and been tested for lifetime allowance purposes, even if they have not been paid yet. Any chargeable amount will have been identified at that time, and a liability to a lifetime allowance charge will have arisen. So there will never be a need or opportunity to pay a lifetime allowance excess lump sum once the member has reached age 75.

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Transfer to a qualifying recognised overseas pension scheme

Where a transfer is going to be made to a qualifying recognised overseas pension scheme, if the member has reached the normal minimum pension age, any part of that transfer payment that would, if paid, generate a chargeable amount, may instead be paid as a lifetime allowance excess lump sum. So the amount representing the member’s available lifetime allowance may be transferred overseas and will crystallise through BCE 8. The rest of the intended transfer payment may be paid to the individual as a lifetime allowance excess lump sum and will crystallise through BCE 6.

If the member has not reached the normal minimum pension age, a lifetime allowance excess lump sum may not be paid. The full amount transferred will then crystallise through BCE 8.

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Order of BCEs where a chargeable amount is going to arise

Where the member exceeds their lifetime allowance when crystallising benefits under a registered pension scheme, the payment of any lifetime allowance excess lump sum must always be treated for lifetime allowance purposes as having occurred after all other BCEs occurring at the same time. This is because the member must have used up all their lifetime allowance before such a lump sum can be paid - see PTM085000.

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Amount of lifetime allowance excess lump sum

Under a money purchase arrangement

With a money purchase arrangement, it is generally clear what level the lifetime allowance excess lump sum will be paid at, as there is a given fund value.

So if there are uncrystallised funds of £200,000, normally £150,000 could be used to purchase a lifetime annuity or provide a drawdown pension, with £50,000 being paid as a pension commencement lump sum. If £100,000 of the amount to crystallise will be a chargeable amount the scheme administrator would give the member the option of drawing £100,000 as a lifetime allowance excess lump sum, after the first £100,000 had been used to purchase a lifetime annuity for £75,000 and to pay £25,000 as a pension commencement lump sum.

Where dealing with a scheme pension entitlement

A crystallised value is initially attributed to the scheme pension through BCE 2 by multiplying the annual level of pension entitlement by a relevant valuation factor, normally of 20 - see PTM088620. Where part of that scheme pension entitlement is reduced in order to generate a lifetime allowance excess lump sum, the scheme needs to fund that lump sum payment from the resources of the scheme. It is not simply a question of distributing a known fund earmarked for that member. So the scheme needs to make a decision as to how much they are prepared to pay as a lump sum in return for the member giving up part (or all) of their scheme pension entitlement.

The scheme may be prepared to commute the pension on a 20:1 basis, but it is more likely that they will use a scheme specific commutation factor, as used by the scheme when converting part of a member’s pension entitlement to a pension commencement lump sum payment. So the lifetime allowance excess lump sum actually paid may not marry up with the estimated chargeable amount identified before any benefits crystallised, as based on the crystallised value of the full scheme pension entitlement - see PTM085000.

The member will generally have the option of taking their full scheme pension entitlement rather than commuting part (or all) for a lifetime allowance excess lump sum. This is a decision the member has to make once the scheme administrator has let them know their options under the scheme rules.

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Example showing the calculation of the chargeable amount

John is a member of a defined benefits arrangement. He decides to take his benefits in a tax year when the standard lifetime allowance is £1.5 million. John has already used up 90 per cent of his lifetime allowance and is subject to the standard lifetime allowance.

John is entitled to a scheme pension of £11,250 per annum and a lump sum of £75,000.

Before paying out the benefits, the scheme administrator calculates the amount that would crystallise for lifetime allowance purposes if those entitlements were drawn. This comes to £300,000 - the scheme pension would crystallise £225,000 through BCE 2 (£11,250 x a relevant valuation factor of 20 added to the £75,000 that would potentially crystallise through BCE 6 on the payment of the lump sum benefit). So the amount crystallising would be 20 per cent of the £1.5 million standard lifetime allowance.

Once the scheme administrator has written to John telling him the above and has received back details of John’s available lifetime allowance, the scheme administrator establishes that only the first £150,000 crystallising will be covered by the available lifetime allowance (10 per cent of £1.5 million). The remaining £150,000 would fall as a chargeable amount, if paid as anticipated by the scheme administrator as a scheme pension/lump sum combination.

Using the 20:1 relevant valuation factor the scheme administrator establishes that a scheme pension of £5,625 (which represents a crystallised value of £112,500 through BCE 2), with the maximum permitted pension commencement lump sum of £37,500, would take John up to his 100 per cent lifetime allowance level. The remaining lump sum entitlement of £37,500 will still be paid, but as a lifetime allowance excess lump sum.

John is given the option of giving up the remaining £5,625 scheme pension in return for a further lifetime allowance excess lump sum. However, the scheme uses a commutation factor of 15:1 to give John £84,375 in return for giving up this part of his pension entitlement.

John decides to take the lump sum option giving a total (gross) lifetime allowance excess lump sum of £121,875 (£37,500 + £84,375). This is the chargeable amount for the purposes of the lifetime allowance charge. After the scheme administrator deducts the 55 per cent lifetime allowance charge due from this payment John gets a net lump sum of £54,844. This net lump sum is the amount which crystallises for lifetime allowance purposes through BCE 6.

The amount actually crystallising for lifetime allowance purposes is £204,844 (£150,000 + £54,844). This is made up of the following elements:

  • the maximum pension commencement lump sum payment of £37,500 crystallising through BCE 6. This is ranked as the first BCE that occurs.
  • the reduced scheme pension entitlement of £5,625 per annum crystallises £112,500 through BCE 2. This is ranked as the second BCE that occurs.
  • a lifetime allowance excess lump sum payment of £54,844 crystallising through BCE 6. This is ranked as the third BCE that occurs.

So the chargeable amount arising is actually only £121,875, not the £150,000 amount anticipated originally, based on John’s full scheme pension entitlement.

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Taxation of a lifetime allowance excess lump sum

Sections 214, 215 and 254 Finance Act 2004

The Registered Pension Schemes (Accounting and Assessment) Regulations 2005 - SI 2005/3454

Section 636A(5) Chapter 15A Income Tax (Earnings and Pensions) Act 2003 inserted by paragraph 11 Schedule 31 Finance Act 2004

Payment of a lifetime allowance excess lump sum will give rise to a chargeable amount. It is this chargeable amount which is subject to a lifetime allowance charge (at the rate of 55 per cent), not the payment of the lump sum itself.

See PTM086000 for details of the liability to pay the charge. PTM164100 gives further details on the form to use, what information must be provided on the form and when and how an amended AFT return should be made.

The actual payment of the lifetime allowance excess lump sum attracts no additional income tax charge in the hands of the recipient.