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HMRC internal manual

Pensions Tax Manual

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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

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 s208 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 s611A 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 s613(4)(b) ICTA 1988 (Parliamentary pension schemes or funds),
  • an annuity under an annuity contract or trust scheme approved under s620 or s621 ICTA 1988 or a substituted contract within the meaning of s622(3) ICTA 1988,
  • an annuity provided from the funds of a personal pension scheme approved under Chapter 4 Part 14 ICTA 1988, or
  • a right to income withdrawals from a personal pension scheme under s634A ICTA 1988.

Only a pension paid to the individual as an actual member of a scheme is within this definition. A widow(er)’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(s) 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 (i.e. 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 per cent of the standard lifetime allowance (£1.25 million).

Brian only has 60 per cent 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) Schedule 36 Finance Act 2004

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

Where:

  • the first BCE in respect of the member is on or after 6 April 2015,
  • the member is aged under 75 at the time of that first BCE
  • the member has a pre-commencement pension that immediately before 6 April 2015 was paid from a capped drawdown pension fund, and
  • that fund on or after 6 April 2015 was converted to a flexi-access drawdown fund through one of the following

    • either 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, or
    • 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 per cent 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.

In all other cases 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 (i.e. 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 per cent 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 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 is 80 per cent 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 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 two 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 per cent 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 two 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 per cent 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 two BCEs, in fact 100 per cent of the standard lifetime allowance has been used up. This is the 40 per cent deemed to have been used up by the pre-commencement pension and the 60 per cent actually used up at the two 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 per cent 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 per cent. 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 per cent, 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 per cent after the 5 per cent 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 per cent 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 per cent 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 per cent 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 per cent of the standard lifetime allowance, but 42.6 per cent (100 per cent - 57.4 per cent). So following the BCE 3 Colin has effectively used up 62 per cent of the standard lifetime allowance, leaving 38 per cent available for the next BCE (if one is triggered).