Benefit crystallisation events and the lifetime allowance charge - all you need to know.
The lifetime allowance (LTA) is the maximum amount that can be crystallised before a charge applies. It used to be £1.8m but it’s steadily decreased to £1m. There’s a whole list of benefit crystallisation events (BCEs) that trigger a test against the LTA, including taking benefits and death.
Let’s look at the most common BCE – taking benefits.
Every time someone takes benefits, the crystallised value is tested against the LTA. The crystallised value for a Defined Contribution (DC) scheme is the amount of the fund whereas for a Defined Benefit (DB) scheme it’s 20 x the pension taken plus the tax-free cash.
Take Karen, who took benefits with a value of £125,000 in 2015 when the LTA was £1.25m. The scheme administrator asks her if she has used up any LTA already and issues her with a statement stating that she’s used up 10% of the LTA with this crystallisation. If she crystallises more funds, she’ll be able to tell the scheme administrator that she’s already used up 10% of the LTA. If her next crystallisation uses up another 20% of the LTA she’s now used up a total of 30% of the LTA and will have 70% left to apply to her next BCE. The 70% will be applied to the LTA prevailing at the time of that BCE.
If she crystallises an amount that’s more than the LTA she has left, the scheme administrator will ask her whether she wants to take the excess as a lump sum or used to provide income. Not all scheme administrators will offer both options. If she chooses a lump sum, a charge of 55% will be deducted by the scheme administrator and paid to HMRC with the balance paid to Karen. This can be paid on top of the tax-free cash taken but remember that tax-free cash is restricted to the lower of 25% of the fund and 25% of the LTA that’s left.
If she chooses income, the charge will be 25% with the balance used to provide an annuity or a drawdown plan.
You can find more detailed case study here.
Some other BCEs happen automatically at age 75. These are:
- BCE 5 – where someone reaches age 75 without having taken any benefits from their DB scheme. The DB pension is valued at 20 x the full pension they would have received if they had taken benefits at age 75. The pension used is the pension before any commutation for tax-free cash. However if tax-free cash is provided separately (as is common in public sector schemes), that would be added in as a lump sum. The total amount is tested against the lifetime allowance available.
- BCE 5A – where someone reaches age 75 having already started drawdown.
Alan crystallised his £200,000 pension fund on 1 October 2007, taking £50,000 tax-free cash with the balance of £150,000 going into drawdown. This used up 12.5% of the 2007/08 lifetime allowance of £1,600,000. On 1 October 2017 (his 75th birthday), the drawdown fund is worth £220,000. The £70,000 growth in the fund is tested against the £875,000, which is 87.5% of the current lifetime allowance, so no lifetime allowance charge is due.
Obviously making withdrawals from the drawdown fund would result in a lower level of growth or no growth at all. However the withdrawals themselves will be liable for income tax, possibly at a 40% or even 45% rate.
BCE 5B – where someone reaches age 75 without having taken benefits yet from a defined contribution scheme. The DC pension fund is then tested against the lifetime allowance available.
After age 75 the only BCE that can happen is where an annuity increases by more than a prescribed amount. This would be a rare occurrence, so for all practical purposes no BCE can happen after age 75.
Death is also a BCE so there’s no escaping an LTA test – an individual’s pension rights will be tested at some point. But an LTA charge will only apply if the BCE value is wholly or partly over the LTA available.