PTM088300 - The lifetime allowance and the lifetime allowance charge: benefit crystallisation events: pensions in payment on 6 April 2006

Glossary PTM000001

When a pre-commencement pension is taken into account for lifetime allowance purposes
How a pre-commencement pension is treated for lifetime allowance purposes
Calculating the capital value of the pre-commencement pension
Where the pre-commencement pension is being paid as a drawdown pension
Examples of calculating the capital value of a pre-commencement pension
Augmentation of a pre-commencement pension being paid as a scheme pension

As of the 6 April 2023 there is no longer a lifetime allowance (LTA) charge. However, for the 2023-24 tax year the concept of lifetime allowance remains, and benefits crystallising still need to be measured against the lifetime allowance.

Relevant lump sums will no longer be subject to an LTA charge but instead there will be a charge to income tax at the individual’s marginal rate.

You can read more about the changes at PTM091100.

For any event that occurs before the 6 April 2023 the below guidance should still be followed and any LTA charges that arise will still apply.

When a pre-commencement pension is taken into account for lifetime allowance purposes

Sections 216(1) - BCE 3, and 219(7) and (8) Finance Act 2004

Paragraphs 10(2) and 20, schedule 36 Finance Act 2004

Article 20 of the Taxation of Pension Schemes (Transitional Provisions) Order - SI 2006/572

A pension benefit in payment from a tax approved source that started being paid before 6 April 2006 is only taken into account for lifetime allowance purposes the first time a benefit crystallisation event (BCE) occurs in respect of the member (see PTM088100).

Such a pension is referred to in the legislation as a ‘pre-commencement pension’. The reason such pensions need to be considered in this way is because, as these pensions in payment arose before 6 April 2006, they will not have been tested for lifetime allowance purposes when they began to be paid.

What pensions represent a pre-commencement pension?

A pre-commencement pension includes a pension paid from a retirement benefits scheme approved under Chapter I Part 14 Income and Corporation Taxes Act (ICTA) 1988:

  • a pension paid from a former approved superannuation fund. These are schemes that were approved under section 208 ICTA 1970 just before 6 April 1980, have not been approved under Chapter I Part 14 ICTA 1988 and have not received any contributions since 5 April 1980
  • a pension paid from a relevant statutory scheme as defined in section 611A ICTA 1988 or a scheme treated by HMRC as if it was a relevant statutory scheme
  • an annuity, or pension paid as income drawdown from an annuity contract used to secure benefits from any of the above 3 types of schemes
  • a pension from a scheme or fund mentioned in section 613(4)(b) ICTA 1988 (Parliamentary pension schemes or funds)
  • an annuity under an annuity contract or trust scheme approved under section 620 or section 621 ICTA 1988 or a substituted contract within the meaning of section 622(3) ICTA 1988
  • an annuity provided from the funds of a personal pension scheme approved under Chapter 4 Part 14 ICTA 1988
  • a right to income withdrawals from a personal pension scheme under section 634A ICTA 1988.

Only a pension paid to the individual as an actual member of a scheme is within this definition. A surviving spouse’s, surviving civil partner’s or dependant’s pension is not treated as a pre-commencement pension.

PTM063250 explains how such pre-commencement pensions are treated from 6 April 2006 onwards, as far as fitting into the post 6 April 2006 regime is concerned. PTM062300 covers the position of a deferred annuity (or ‘section 32’) policy in existence on 5 April 2006.

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How a pre-commencement pension is treated for lifetime allowance purposes

Where the first BCE in relation to an individual occurs, the amount of lifetime allowance available at that first (and subsequent) BCE or BCEs will be reduced. The value of any pre-commencement pensions in payment to the member at that time reduces the member’s available lifetime allowance for their first actual BCE. For the avoidance of doubt, where the first BCE that occurs after 5 April 2006 is BCE 5C, BCE 5D or BCE 7 - the relevant post-death BCEs - the pre-commencement pension will still reduce the amount of lifetime allowance available for the BCE5C, BCE 5D or BCE 7.

No actual BCE occurs in respect of that pre-commencement pension, so no chargeable amount will ever be generated by it.

If the value of the pre-commencement pension equals or exceeds the member’s lifetime allowance the member has no available lifetime allowance at that first BCE. This means that the entire amount crystallising at that first BCE will represent a chargeable amount.

How the crystallised value of such a pre-commencement pension is calculated depends on the nature of the pension in payment. The calculation is based on the level of pension in payment at that deemed BCE date (see below).

PTM164400 explains how the reduction of the available lifetime allowance at that first BCE (and any subsequent BCEs) is recorded for member statement purposes.

If no BCE is triggered on or after 6 April 2006, the pre-commencement pensions will never be considered for lifetime allowance purposes.

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Calculating the capital value of the pre-commencement pension

The crystallised value of a pre-commencement pension is calculated by multiplying the annual rate of the pension in payment (referred to in the legislation as ‘ARP’) at the point of calculation by a conversion factor.

The factor for valuing such pensions is 25:1 regardless of whether it is a scheme pension, a pre-6 April 2006 annuity contract etc.

The factor reflects that the member will in almost all circumstances have taken, or had the opportunity to take, a tax-free lump sum when initially drawing the pension.

The 25:1 factor should be applied to the annual rate of pension payable to the member on the day that first BCE occurs after 5 April 2006 (that is, not to the annual rate in payment on 5 April 2006).

Example

On 5 April 2006 Brian is in receipt of an annual pension of £15,000 per annum.

Some years later, when the standard lifetime allowance is £1.25 million, Brian becomes subject to a BCE. This is his first BCE post- 5 April 2006. At that time, his pre-commencement pension in payment is £20,000 annually.

Brian’s level of available lifetime allowance at that first BCE is reduced to reflect the level of pre-commencement pension in payment at that time. The rate to be used is the annual rate in payment at the BCE, not 5 April 2006.

The amount Brian’s available lifetime allowance is reduced by is £500,000 (25 x £20,000). This represents 40% of the standard lifetime allowance (£1.25 million).

Brian only has 60% of the standard lifetime allowance available at that first BCE.

Where there is more than one pre-commencement pension in payment the annual rate of each would be aggregated into ‘ARP’ before applying the 25:1 conversion factor.

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Where the pre-commencement pension is being paid as a drawdown pension

Paragraph 20(4) Sshedule 36 Finance Act 2004

The guidance that follows only applies where the first BCE in relation to the member occurs on or after 6 April 2015.

For guidance on the maximum of capped drawdown pension payable in any particular drawdown year see PTM062530.

Where the pre-commencement pension is still being paid at the point of that first BCE as a capped drawdown pension and the member has not reached age 75

Paragraph 20(4)(a) schedule 36 Finance Act 2004

Where the member is under 75 at their first BCE and their pre-commencement pension at the point of that first BCE is being paid as a capped drawdown pension (that is, there has been no flexible drawdown declaration and it has not converted to flexi-access drawdown since 5 April 2015) ‘ARP’ for the purpose of the lifetime allowance reduction on the first BCE is 80% of the maximum annual amount of capped drawdown pension payable in the drawdown pension year in which the first BCE falls, as determined at the most recent valuation/review of the member’s fund.

Where a flexible drawdown declaration was accepted by a scheme administrator before 6 April 2015 in relation to a pre-commencement pension that was being paid as drawdown pension and the member has not reached age 75

Paragraph 20(4)(b) schedule 36 Finance Act 2004

Where a member designated funds as available for the payment of drawdown pension before 6 April 2015 and qualified to take their pension as flexible drawdown (see PTM062580 onwards for more detail) then, on 6 April 2015, the sums and assets so designated were member-designated funds (as are any sums or assets held for the purpose of the arrangement which arise directly or indirectly from such member-designated funds or from sums or assets which so arise or derive) provided that at 5 April 2015 they had not been applied towards the provision of a scheme pension.

As of 6 April 2015, the member’s flexible drawdown pension fund automatically converted into a flexi-access drawdown fund, the funds ceased to be member-designated funds and become newly-designated funds.

In such cases, where the member is under 75 at the first BCE and immediately before 6 April 2015 the pre-commencement pension was being paid from a flexible drawdown pension fund, ‘ARP’ for the purposes of the lifetime allowance reduction on the first BCE depends on when the member’s flexible drawdown declaration was accepted.

Where the declaration was accepted in a drawdown pension year that began before 27 March 2014, ARP is 100% of the maximum annual amount of capped drawdown pension that would have been payable in the drawdown pension year in which the flexible drawdown declaration was accepted by the scheme administrator, had the flexible drawdown declaration not been made.

Where the declaration was accepted in a drawdown pension year that began on or after 27 March 2014, ARP is 80% of the maximum annual amount of capped drawdown pension that would have been payable in the drawdown pension year in which the flexible drawdown declaration was accepted by the scheme administrator, had the flexible drawdown declaration not been made.

The reason for this difference in calculating ARP is to ensure consistency of treatment. The maximum amount of drawdown pension that a pension arrangement can pay the member each year is expressed as a percentage of an equivalent annuity that could be purchased with the member’s drawdown pension fund (‘the basis amount’). Flexible drawdown was introduced with effect from 6 April 2011. At that time the maximum amount was 120% of the basis amount. The percentage was increased to 150% of the basis amount for drawdown pension years beginning on or after 27 March 2014. 80% of this maximum is equivalent to 100% of the previous maximum so the reduction from 100% to 80% gives ARP equal to 120% of the basis amount regardless of the drawdown year in which the declaration was accepted.

Where the pre-commencement pension is being paid at the point of that first BCE as flexi-access and the member has not reached age 75

Paragraph 20(4)(c) schedule 36 Finance Act 2004

Where the member is under 75 at their first BCE and their pre-commencement pension at the point of that first BCE was being paid as a capped drawdown before 6 April 2015, and on or after 6 April 2015 was converted to a flexi-access drawdown fund through one of the following:

  • a payment of income withdrawal from the fund or a payment of short-term annuity purchased using sums or assets out of the fund was made which would have breached the cap
  • the scheme administrator accepted the member’s notification that the fund was to become a flexi-access drawdown fund
  • transferred-in funds from a capped drawdown arrangement in another registered pension scheme have at the choice of the member become flexi-access drawdown funds in the receiving scheme

’ARP’ in relation to this pre-commencement pension, for the purposes of the lifetime allowance reduction, on the first BCE is 80% of the maximum annual drawdown amount that could have been paid under the capped drawdown rules in the drawdown pension year in which the fund converted to flexi-access.

Where the pre-commencement pension is being paid at the point of that first BCE as a drawdown pension when the member has reached age 75

The guidance above also applies where the pre-commencement pension is being paid from a scheme at the point of that first BCE as a drawdown pension and the member has reached age 75.

The only BCE that can occur on or after age 75 is a BCE 3. The only occasion therefore where this would apply would be where the first BCE triggering the test was the augmentation beyond the permitted margin of another pre-commencement pension being paid as a scheme pension. The pre-commencement scheme pension being augmented would also be deemed to crystallise before the BCE - see examples below.

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Examples of calculating the capital value of a pre-commencement pension

Example 1

On 6 April 2006 John had £700,000 held in a money purchase arrangement. John was also in receipt of a level scheme pension of £20,000 annually, which started before 6 April 2006 so is a pre-commencement pension for lifetime allowance purposes.

On 8 August 2015 John crystallises his benefits under the money purchase arrangement. This triggers 2 BCEs, the payment of a relevant lump sum - BCE 6 - and the designation to provide a drawdown pension - BCE 1. The crystallised value of the benefits taken is £750,000, which represents 60% of the standard lifetime allowance in 2015-16.

As this is John’s first BCE after 5 April 2006 the available lifetime allowance at the first of these 2 BCEs (BCE 6) is reduced by the crystallised value of the pre-commencement pension on 8 August 2015.

The capital value of the scheme pension in payment (‘ARP’) on 8 August 2015 is calculated at £500,000 (25 x £20,000). This represents 40% of the standard lifetime allowance (£1.25 million). His available lifetime allowance at that first BCE is therefore only 60per cent of the standard lifetime allowance.

The scheme administrator calculates that, after the 2 BCEs, in fact 100% of the standard lifetime allowance has been used up. This is the 40% deemed to have been used up by the pre-commencement pension and the 60% actually used up at the 2 BCEs (BCE 1 and BCE 6).

Example 2- the calculation of the capital value of a pre-commencement pension which uses all the available lifetime allowance

On 6 April 2006 Tracey has £700,000 held in a money purchase arrangement. She is also in receipt of a level scheme pension of £80,000 per annum. As this scheme pension started before 6 April 2006 it is a pre-commencement pension for lifetime allowance purposes.

On 8 November 2015 Tracey crystallises her benefits under the money purchase arrangement, creating a BCE. The crystallised value of the benefits is £750,000, which represents 60% of the standard lifetime allowance for 2015-16.

But as this is Tracey’s first BCE after 5 April 2006 the available lifetime allowance is reduced by the crystallised value of the pre-commencement pension (the scheme pension) on 8 November 2015.

The crystallised value of the pre-commencement pension is £2 million (25 x £80,000). This is more than Tracey’s level of available lifetime allowance (£1.25 million). So, she has no available lifetime allowance at that first BCE post-5 April 2006.

This means that all the benefits crystallising under the money purchase arrangement will constitute a chargeable amount. The chargeable amount will not be increased because the crystallised value of the pre-commencement pension (£2 million) exceeds Tracey’s actual available lifetime allowance level (£1.25 million).

Tracey cannot be paid a pension commencement lump sum as she has no available lifetime allowance. Tracey decides to take all her benefits as a lifetime allowance excess lump sum.

The payment of the £750,000 lifetime allowance excess lump sum crystallises through BCE 6. This £750,000 all represents a chargeable amount and tax is charged at the rate of 55%. The scheme administrator deducts the £412,500 lifetime allowance charge due before paying the balance to Tracey, and accounts for the charge due direct with HMRC.

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Augmentation of a pre-commencement pension being paid as a scheme pension

Where a scheme pension in payment is increased beyond a permitted margin, the excess increase crystallises for lifetime allowance purposes through BCE 3 (see PTM088630).

This rule also applies to a pre-commencement pension that continues to be paid on or after 6 April 2006 and is treated as a scheme pension from that date, although the permitted margin for pre-commencement pensions is different from that for post-6 April 2006 pensions.

If a BCE 3 is the first BCE in relation to the member, the values of any existing pre-commencement pensions must be taken into account for lifetime allowance purposes. This includes the value of the pre-commencement scheme pension being augmented, in relation to which the BCE 3 has occurred.

The excess increase is valued for BCE 3 but the level of available lifetime allowance at that BCE is reduced by the crystallised, capital value of the pre-commencement scheme pension itself, valued on the basis of its value before the triggering augmentation.

Any other pre-commencement pension in payment to that member will also reduce the amount of available lifetime allowance on the BCE 3.

Example of augmenting a pre-commencement scheme pension

On 5 April 2006 Colin is in receipt of an annual pension of £34,000. He has no other pension benefit in payment. From 6 April 2006 onwards this pension meets the definition of a scheme pension.

Colin’s pension in payment increases each year by 5%. Such increases do not trigger a benefit crystallisation event through BCE 3 as they are within the permitted margin.

On 8 April 2010 Colin’s annual pension has again been increased by 5%, taking his pension to £41,330 per annum. However, at that point the employer/scheme administrator also agrees to augment Colin’s pension by another 10% after the 5% per annum increase.

As this increase is given to Colin alone and goes beyond the permitted margin an amount crystallises through BCE 3. The crystallised amount at this event is:

20 x the excess augmentation (XP).

XP = £4,133 (the 10% rise, over and above the permitted margin).

20 x £4,133 = £82,660.

So, the amount crystallising through BCE 3 is £82,660, which represents 4.6% of the standard lifetime allowance of £1.8 million for the 2010/11 tax year.

This is Colin’s first BCE after 5 April 2006. As his scheme pension is a pre-commencement pension the crystallised value of this pension needs to be considered when calculating his available lifetime allowance at that BCE.

The annual pension in payment before the augmentation was £41,330. So the crystallised value of this pension is calculated as being £1,033,250 (25 x £41,330). This represents 57.4% of the standard lifetime allowance of £1.8 million for the 2010/11 tax year.

Colin’s available lifetime allowance at that first BCE (BCE 3) is not 100% of the standard lifetime allowance, but 42.6% (100% - 57.4%). So, following the BCE 3 Colin has effectively used up 62% of the standard lifetime allowance, leaving 38% available for the next BCE (if one is triggered).