A guide to the pension lifetime allowance changes
What is the lifetime allowance?
The lifetime allowance is the maximum pensions savings you can build up without a tax charge over your lifetime. It is currently £1.25 million but it is set to reduce to £1 million on 6 April 2016.
Your pension benefits are tested against the lifetime allowance when you start to draw them from the scheme. This may be in one go or at different times depending on how you draw your benefits.
Anything over the lifetime allowance will have a tax charge of either 25% if the residual money is left within the scheme to take as taxed income or 55% if the money is taken out as a lump sum at the time of the test. If you don’t draw your benefits before your death the value of them will be tested at that point and a tax charge on the part over the lifetime allowance may be chargeable to your beneficiaries.
When you draw benefits, only your pension commencement lump sum, usually 25% of the fund, will be tax free, the remainder will be drawn as an income which you will pay tax on it in the same way as you would a salary (PAYE).
How will I know if I will be affected?
You will need to know the level of pension saving you have already and this will depend on the type of pension scheme you have.
If you have a money purchase (defined contribution) pension scheme then it is simply the value of the fund including any pension commencement lump sum you are entitled too.
If you have a final salary (defined benefit) pension scheme then you need to know the amount of pension you would be paid assuming it were possible for you to take unreduced benefits on 5 April 2016. You then need to multiply this by 20 and add any pension commencement lump sum to the total.
You may have many different schemes and you will need to add them all together to get your pensions savings for lifetime allowance purposes.
What should I do if I think this affects me?
There is nothing you can currently do about the reduction in 2016, although should you discover that your pension savings are already over £1.25 million there is still time to look into individual protection 2014, which is available to apply for until 5 April 2017.
This means that you would have your own personal lifetime allowance set at the same value of your pensions savings at 5 April 2014 up to a maximum of £1.5 million. You will need to ask your pension providers for valuation as this date to check if you are eligible and then complete the form online at https://online.hmrc.gov.uk/shortforms/form/IP2014?dept-name=&sub-dept-name=&location=36&origin=http://www.hmrc.gov.uk. It is not possible to apply for individual protection 2014 if you already have primary protection which you would have applied for between 2006 and 2009.
It has been proposed that there will be two types of protection available to those who want to apply for protection against the drop in the lifetime allowance in 2016, one called fixed protection 2016 and one called individual protection 2016. Although these have been announced the actual legislation has not been produced yet, we are assured it will be available in advance of the deadlines, along with the forms to give people plenty of time to apply for the most appropriate protection.
Which protection is right for me?
It is not possible to say for certain which protection is the most appropriate because it will depend on a number of factors, including future pension savings and how long you have until retirement but there are certain aspects of each protection which may lead you to apply for one or even both options.
Fixed protection 2016 will give you a set lifetime allowance of £1.25 million, whatever the value of your pension savings now, but you need to be careful as it only remains valid if you cease to contribute to pension schemes in the future. Should you make a contribution to a money purchase scheme or accrue benefits in a final salary scheme above the basic annual increases then you will lose your fixed protection 2016 and revert back to the standard lifetime allowance at that time. Fixed protection 2016 will need to be applied for when the forms are available and before 6 April 2016.
Individual protection 2016 will give you a personal lifetime allowance depending on the value of your pension savings at 5 April 2016. Your savings will need to be over £1 million to apply and the maximum you can protect is £1.25 million so you will need to obtain accurate figures from your pension providers for the application forms. The application will probably be available from 6April 2016 to 5th April 2019, which gives you time to get and collate any pension figures from multiple providers.