With the impending reduction in the Lifetime Allowance from £1.8 million to £1.5 million, quirks in the legislation means that for certain individuals looking to take benefits over the coming months, timing could make all the difference.
Those with Primary Protection or scheme specific tax-free cash will be assigned an underpinned lifetime allowance of at least £1.8 million, as transitional protection to offset the reduction. On initial inspection it would appear that the reduction in the lifetime allowance will have no impact on such rights. However, because of the underlying formulas used to establish and maintain these rights, whether benefits are drawn before or after 6 April 2012 could make a difference to the overall level of benefits available, as outlined below.
Scheme specific tax-free cash
Any tax-free cash rights established as more than the standard 25% of the corresponding fund value prior to A Day (6 April 2006) is protected and granted an element of escalation until retirement*, in line with the change in the lifetime allowance over the term. From April 2012, this protected amount retains the right to be increased using the underpinned lifetime allowance of £1.8 million (or the standard lifetime allowance if greater). This effectively secures a minimum increase of 20%.
In addition to this amount, extra tax-free cash rights can also accrue dependent on the level of any fund growth between A Day and retirement*. If the fund value at retirement exceeds the A Day fund value re-valued in line with the change in the lifetime allowance, further tax-free cash is available based on 25% of this excess growth. However, the £1.8 million underpin is not applicable to this calculation, and so any fall in the standard lifetime allowance at retirement will effectively enhance any extra tax-free cash benefit available. Therefore, when the lifetime allowance reduces to £1.5 million, the level it was when first introduced on A Day, the calculation of extra tax-free rights will be based on the full value of any fund growth.
For example:
For a client with scheme specific tax-free cash of £40,000 out of a fund of £80,000 pre A Day, and a current value of £110,000:
- If benefits are taken before 6 April 2012 – overall maximum tax-free cash equates to £51,500
- If benefits are taken on/after 6 April 2012 – overall maximum tax-free cash equates to £55,500
A difference of £4,000!
For those with scheme specific tax-free cash rights, simply taking benefits on 6 April 2012 rather than the day before could produce a significant increase in their overall tax-free cash entitlement.
Please note that for those with fixed protection on/after 6 April 2012, i.e. the right to retain a lifetime allowance of £1.8 million, this underpin will apply to the calculation for extra tax-free cash, and so deferral would not offer the same advantages described here.
Primary Protection
Individuals with Primary Protection are given a lifetime allowance enhancement, referred to as a personal lifetime allowance, which from 6 April 2012 will be based on the underpinned lifetime allowance described above. Because of the way in which legislation requires the personal lifetime allowance to be determined and benefits previously taken to be re-valued over time, by simply taking some benefits before 6 April 2012 could increase an individual’s remaining personal lifetime allowance after this date.
Each time benefits are taken, they are assessed against the current lifetime allowance, i.e. the lifetime allowance at that time. Therefore, benefits taken between now and 6 April 2012 will be assessed using the current lifetime allowance of £1.8 million, to establish the amount of lifetime allowance ‘used up’; expressed as a percentage. However, where primary protection is in place, when further benefits are taken post 6 April 2012, the original benefits have to be re-valued based on the change in the standard lifetime allowance, and the £1.8 million underpin is not applicable to this calculation. Therefore, the reduction in the lifetime allowance will effectively de-value the original benefits taken. The net result is an increase in the remaining personal lifetime allowance.
For example:
For a client looking to take benefits worth £360,000;
- If taken before 6 April 2012, the £360,000 will use up 20% of the standard lifetime allowance (£1.8 million).
On/after 6 April 2012 when further benefits are taken, the value of the original benefit reduces to £300,000 (£1.5 million x 20%).
- If taken on/after 6 April 2012, the £360,000 will use up 24% of the standard lifetime allowance (£1.5 million).
For those individuals with funds on or around their Primary Protection limit, taking some benefits before 6 April 2012 can therefore increase their personal lifetime allowance remaining after that date. Also, the greater the benefits taken before this date, the greater the impact on the remaining personal lifetime allowance. This increase in limit can then be used to reduce a lifetime allowance (where applicable), or increase the headroom for paying additional contributions.
This information in this article is based on our understanding of current legislation which may change in the future.
* in relation to this briefing, retirement refers to when benefits are taken.