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Pensions Tax Manual

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The lifetime allowance and the lifetime allowance charge: benefit crystallisation events: each of the benefit crystallisation events (BCEs) in detail: BCE 4 purchase of a lifetime annuity

Glossary PTM000001
   

 

When a lifetime allowance test is triggered through BCE 4
When a lifetime allowance test is not triggered through BCE 4
Calculating the crystallised amount where a lifetime annuity is purchased from uncrystallised funds
Prevention of overlap where drawdown pension fund or flexi-access drawdown fund is used to purchase a lifetime annuity
Where only part of the drawdown pension fund or flexi-access drawdown fund is used to purchase a lifetime annuity
 

Section 216(1)-BCE 4, and section 165 ‘pension rule 4’, Finance Act 2004

Paragraphs 2, 4 and 7, Schedule 32 Finance Act 2004

Article 29 The Taxation of Pension Schemes (Transitional Provisions) Order 2006 - SI 2006/572

See PTM088100 for an overview of the benefit crystallisation events (BCEs) and the lifetime allowance.

When a lifetime allowance test is triggered through BCE 4

A lifetime allowance test is triggered through BCE 4 every time a lifetime annuity contract is purchased under a money purchase arrangement before the member has reached age 75.  Where the lifetime annuity is purchased after the member has reached age 75 there is no BCE 4 as the only BCE that can occur after age 75 is a BCE 3 - see PTM088630

This applies whether or not a related dependants’ or related nominees’ annuity is provided for under the same contract (see later comments on joint-life annuity contracts). The effective date of the BCE is the date the member actually becomes entitled to the annuity payments which will generally be when the contract is purchased.

BCE 4 only covers money purchase arrangements as only these arrangements can provide benefits through this means. PTM088620 explains the difference where a scheme pension is secured through the purchase of an annuity from an insurance company.

BCE 4 is triggered where annuity purchased from uncrystallised funds or a drawdown pension fund or flexi-access drawdown fund

A lifetime allowance test is triggered through BCE 4 where before the member reaches age 75 the lifetime annuity is purchased from uncrystallised funds or from a drawdown pension fund or flexi-access drawdown fund held in a money purchase arrangement. Where drawdown funds are used to buy the annuity, the amount crystallising through BCE 4 will be lower in value to reflect the fact that the value of the sums or assets designated to those funds was tested previously for lifetime allowance purposes through BCE 1.

Where an entitlement to the drawdown pension arose before 6 April 2006

Any pension being paid to a member aged under 75 on 5 April 2006:

  • as income withdrawal from a personal pension scheme
  • direct from the funds of a small self-administered scheme (SSAS) in accordance with paragraphs 20.39 to 20.42 of the IR12(2001) Practice Notes on the Approval of Occupational Pension Schemes and the scheme rules did not require an annuity to be purchased for the individual
  • direct from the funds of a SSAS approved under s 590 ICTA 1988 where the scheme rules did not require an annuity to be purchased for the individual, or
  • as income drawdown to a member aged under 75 from any retirement benefits scheme (including a SSAS) within the requirements laid out in Appendix XII of the IR12(2001) Practice Notes on the Approval of Occupational Pension Schemes,

from a money purchase arrangement in a scheme that became a registered pension scheme on 6 April 2006 became an unsecured (drawdown) pension from 6 April 2006 onwards. The sums and assets used to fund this pension became a drawdown pension fund held in a separate ‘ring-fenced’ arrangement to which no further contributions may be made.

No BCE4 arises when a lifetime annuity is purchased in relation to a pension to which entitlement arose before 6 April 2006, and which became an unsecured pension from 6 April 2006. To ensure the rights under the arrangement are not mixed with rights that are to be tested against the lifetime allowance, the rights to the pre-6 April 2006 drawdown pension should be kept in a separate arrangement.

For more information on pre commencement pensions, see PTM088300.

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When a lifetime allowance test is not triggered through BCE 4

A short-term annuity contract

The purchase of a short-term annuity from a drawdown pension fund is not a BCE 4 or any other BCE. This is because the initial designation of funds for drawdown pension would have been tested through BCE 1, and the short-term annuity is simply a means of securing the resulting drawdown pension.

Where a lifetime annuity is purchased before normal minimum pension age

A lifetime allowance test is not triggered through BCE 4 if a lifetime annuity contract is purchased before the member reaches their normal minimum pension age, does not have a protected pension age and the ill-health condition is not met because this would represent an unauthorised member payment.  A lifetime allowance test is then triggered when the member reaches normal minimum pension age.  The amount crystallises through BCE 2 - see PTM088620

Where a lifetime annuity is purchased on or after age 75 from a drawdown pension fund or flexi-access drawdown fund

Where a lifetime annuity contract is purchased from a drawdown pension fund or flexi-access drawdown fund after the member has attained the age of 75, there is no BCE 4 and there is no other lifetime allowance test. This is because those funds will already have been tested for lifetime allowance purposes through BCE 1 and, if it applied, BCE 5A or 5B.

Where the entitlement to the unsecured pension arose before 6 April 2006

There will be no BCE4 or BCE 2 or BCE 5A in respect of so much of a lifetime annuity or scheme pension that is purchased from a drawdown pension fund or flexi-access drawdown fund that represents drawdown pension in payment on 5 April 2006 - see PTM088300.

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Calculating the crystallised amount where a lifetime annuity is purchased from uncrystallised funds

The capital value of the lifetime annuity contract crystallising for lifetime allowance purposes is easily established where purchased from uncrystallised funds. It is the cost of purchasing the lifetime annuity from the insurance company.

The legislation refers to this as the sums and market value of the assets applied in purchasing the lifetime annuity.

Where a chargeable amount arises, any lifetime allowance charge paid by the scheme administrator effectively forms part of that chargeable amount. The amount crystallising through BCE 4 will be the actual amount used to purchase the lifetime annuity and any related dependants’ or nominees’ annuity, net of any deduction made by the scheme administrator to cover any lifetime allowance charge due. The chargeable amount will be what crystallises (net) through BCE 4 (and any other BCE), over and above the member’s available lifetime allowance, plus the charge paid by the scheme administrator.

Example

Anne is aged 60 and has benefits worth £200,000 held as uncrystallised funds in a money purchase arrangement.

On 23 July 2013 she draws benefits from half her uncrystallised funds. She takes the maximum pension commencement lump sum (£25,000) and uses the remaining £75,000 to secure a lifetime annuity contract through the open market option.

At that point a lifetime allowance test is triggered. There have been two BCEs on that date. These are BCE 6 - the payment of the pension commencement lump sum and BCE 4 -the purchase of a lifetime annuity.

The scheme administrator calculates the capital value of the benefits crystallised on the date as £100,000. This is based on the actual lump sum paid (£25,000) and the £75,000 cost of purchasing the lifetime annuity. This represents 6.66per cent of the standard lifetime allowance for the 2013-14 tax year (£1.5 million).

Purchase of a joint-life annuity contract

Paragraph 4(1) Schedule 32 Finance Act 2004

Paragraphs 31 and 32 Schedule 10 Finance Act 2005

Where a dependants’ or nominees’ annuity is purchased under the same contract as a lifetime annuity (a joint-life annuity), or a dependants’ or nominees’ annuity is purchased that is deemed to be related to the purchase of a particular lifetime annuity contract - see PTM062400, the combined purchase price of the joint-life contract or those two contracts crystallises through BCE 4.

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Prevention of overlap where drawdown pension fund or flexi-access drawdown fund is used to purchase a lifetime annuity

The legislation provides rules to ensure that benefits are not tested through a BCE more than once. This is referred to in the legislation as prevention of overlap.

Where a lifetime annuity, including an annuity purchased with a related dependants’ or nominees’ annuity, is purchased

  • before the member reaches the age of 75,
  • following a period of drawdown pension, i.e. it is purchased (wholly or in part) from a drawdown pension fund or a flexi-access drawdown fund rather than from uncrystallised funds,

the amount crystallising under BCE 4 is reduced to reflect that all (or part of) the funds being used have already been tested for lifetime allowance purposes through BCE1, when uncrystallised funds were originally designated into that fund to provide a drawdown pension.

In this situation, the legislation provides for the reduction of the amount crystallising through BCE 4 by the amount that crystallised at the earlier event (or events). So the amount crystallising through BCE 4 will be reduced by what previously crystallised though BCE 1 when uncrystallised funds were introduced into the drawdown pension fund or flexi-access drawdown fund.

If the amount crystallising through BCE 4 is reduced to ‘nil’ or a negative amount then no amount has been crystallised and no lifetime allowance has been used up. This will be the case where the drawdown pension fund or flexi-access drawdown fund has not grown in value over time (for example, where the pension drawn from the fund has been greater than any growth of the underlying assets).

A negative amount does not mean that the member’s available lifetime allowance is increased.

The two examples below illustrate this.

 

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Where only part of the drawdown pension fund or flexi-access drawdown fund is used to purchase a lifetime annuity

Where only part of the drawdown pension fund or flex-access drawdown fund is used to purchase a lifetime annuity, or the drawdown pension fund concerned was built up by several previous designations of uncrystallised funds, the amount the BCE 4 crystallised value is reduced by is calculated on a pro-rata basis.

For example, a lifetime annuity is purchased using half of the funds of a drawdown pension fund that was generated by three designations at different times. For each designation £100,000 was deemed to have crystallised, giving a total deemed crystallisation value of £300,000 for the drawdown pension fund. As only half the fund is used to purchase the lifetime annuity the amount crystallising under BCE 4 is the annuity purchase price less £150,000 (half the total crystallised value of the drawdown pension fund).

Example 1

Andy is aged 55 and has benefits worth £200,000 held in a money purchase arrangement. On 5 August 2013 Andy draws all his benefits, taking a pension commencement lump sum of £50,000 and using the remaining funds to provide a drawdown pension.

Two BCEs have occurred - BCE 1 for the designation of funds for a drawdown pension and BCE 6 for the provision of the pension commencement lump sum. A lifetime allowance test is triggered.

The amount crystallised through BCE 1 is £150,000 (i.e. what becomes a drawdown pension fund at that point). The amount crystallising through BCE 6 is £50,000. The scheme administrator calculates that the benefits taken represent 13.33per cent of the standard lifetime allowance (£1.5 million for that tax year).

On 5 August 2014, Andy decides to use all the drawdown pension fund to purchase a lifetime annuity contract. Andy has drawn very little drawdown pension and so his drawdown pension fund has grown to £180,000 at that time.

A lifetime allowance test is triggered through BCE 4 when the annuity contract is purchased. The amount crystallised is reduced by £150,000 to reflect the amount that crystallised previously through BCE 1 when the funds were originally designated to provide drawdown pension.

The amount crystallised is therefore only £30,000 (£180,000 - £150,000).

Example 2

As above, but the drawdown pension fund used to buy the lifetime annuity stands at £120,000 as Andy has been drawing a higher level of pension.

BCE 4 is triggered, but because the £120,000 notional amount crystallising through BCE 4 is reduced by the £150,000 that crystallised through BCE 1 in August 2013, on the creation of the drawdown pension fund that has been used to purchase the lifetime annuity, the £120,000 annuity purchase price is cancelled out. As nothing crystallises at that point Andy uses up no lifetime allowance on the purchase of the lifetime annuity.

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