Quantifying the impact of a lifetime allowance charge
Every individual has a lifetime allowance (LTA) which sets the total capital value of pension savings that they can draw as tax privileged benefits. There’s no limit to the amount of pension savings an individual can have. However, tax privileges are recouped through the LTA charge where the LTA is exceeded.
In this technical article I will focus solely on where individuals exceed the LTA during their lifetime, and how the resultant LTA charge is calculated and accounted for.
A test against an individual’s LTA is carried out on the occurrence of a benefit crystallisation event (BCE). Normally BCEs use up their available LTA in the chronological order in which they occur.
However, where a pension commencement lump sum (PCLS) is paid, the BCE will always be treated for LTA purposes as occurring immediately before the BCE of the associated pension benefit.
The payment of any lifetime allowance excess lump sum must always be treated, for LTA purposes, as having occurred after all other BCEs occurring at the same time.
Liability for a LTA charge arises where a ‘chargeable amount’ is identified at a BCE. A chargeable amount is present where the amount crystallised at a BCE exceeds the individual’s remaining LTA.
Any part of the chargeable amount that’s paid as a lump sum is referred to as the ‘lump sum amount’. The LTA charge due on the lump sum amount is 55 per cent. Any remaining part of the chargeable amount is referred to as the ‘retained amount’, as it will be retained by the scheme to provide pension benefits. The LTA charge levied on the retained amount is 25%.
Let’s put this into practice:
Billy, aged 70, is about to fully cyrstallise his SIPP, total value £300,000, taking the maximum PCLS and designating the remainder for drawdown. He has £200,000 LTA remaining to deal with the benefits he’s about to take and has no form of PCLS protection.
Scenario 1: retained amount
Dealing with the BCEs in the order in which they occur.
BCE 6 (PCLS): amount crystallised = 25% of £200,000 = £50,000
BCE 1 (drawdown):
LTA charge = 25% of chargeable amount = 25% of £100,000 = £25,000
Resulting drawdown fund will amount to £225,000
Scenario 2: LTA excess lump sum
BCE 6 (PCLS): amount crystallised = £50,000
BCE 1 (drawdown): amount crystallised = £150,000
BCE 6 (LTA excess lump sum):
LTA charge = 55% of chargeable amount = 55% of £100,000 = £55,000
Net lump sum will be £45,000
It’s important to note that the LTA charge applies regardless of whether any of the persons liable to it are resident or domiciled in the UK.
Where an LTA charge arises during an individual’s lifetime, they and the scheme administrator of the scheme where the chargeable amount arises, are ‘jointly and severally liable’ to the LTA charge.
Joint and several liability means that both the scheme administrator and the individual are equally and separately liable for the whole charge, and that payment by one will discharge the liability of the other, to the extent of the amount paid.
Where this joint and several liability exists, the scheme administrator is obliged to pay and account to HMRC for any LTA charge through the Accounting for Tax (AFT) return. However, if they fail to do this because they’ve acted on incomplete or incorrect information provided by the individual, they may be discharged from their liability to the LTA charge where they can show, and HMRC accepts, that it would not be just or reasonable for them to be liable for it. In that case, liability for the charge would fall solely on the individual.
The individual must declare any LTA charge on their self-assessment tax return for the tax year in which the date of the BCE that generated the charge falls. This is done by completing the ‘Pension Savings Tax Charges’ section (boxes 7 to 9) on page Ai 4 of the additional information pages of the tax return.
A credit for any charge paid by the scheme administrator can be claimed by the individual on their self-assessment return. The scheme administrator will provide a notice confirming the rate of charge due and the amount paid by the scheme to help the individual do this.
Being able to quantify the impact of the LTA charge from a retirement planning perspective is crucial for advisers, as is knowledge of the associated reporting procedures if they are to successfully guide their clients as they transition from the accumulation to de-accumulation phase in their retirement journey.
This article first appeared on Money Marketing