The lifetime allowance is the maximum amount a person can build up in pension savings without incurring a tax charge. The amount of the lifetime allowance fell on 6 April 2012 from £1.8 million to £1.5 million. It will fall again to £1.25 million on 6 April 2014.
Where a person's pension savings exceed the lifetime allowance, a tax charge, known as the lifetime allowance charge, becomes payable.
A pension scheme will test whether a member has exceeded the lifetime allowance only when a "benefit crystallisation event" occurs. That usually means when the member starts drawing his pension benefits.
When excess over the lifetime allowance is used to provide a pension it is taxed at 25%. If used to provide a lump sum, the excess is taxed at 55%. Members can usually take the excess as a lump sum.
Paying the tax charge
Usually, the scheme deducts any lifetime allowance charge payable from the member's benefits and pays HMRC on his behalf. The member will still need to report this in his self-assessment tax return.
Protecting higher levels of lifetime allowance
Some individuals benefit from non-standard lifetime allowances. On the introduction of the lifetime allowance in 6 April 2006, individuals were able to apply for an increased annual allowance based on their then pension savings (primary protection) or they could take themselves outside the lifetime allowance regime (enhanced protection). Similarly, individuals were able to retain a lifetime allowance of £1.8 million after 6 April 2012 by applying for fixed protection. Similar protection will be introduced for the reduction from 6 April 2014 of the lifetime allowance to £1.25 million. The important point to remember is that both fixed protection and enhanced protection are lost if the individual builds up any additional pension savings.
From 2012, employers will be required by law to start auto-enrolling certain workers into qualifying pension schemes. Auto-enrolment applies to workers who have fixed or enhanced protection in the usual way. Those workers must opt out of the pension scheme within the one month deadline to ensure they do not lose that protection. Employers can provide information to those workers about the implications of auto-enrolment, but they cannot automatically opt them out.
Role of trustees and employers
Pension scheme trustees and employers will not necessarily know whether their scheme members are affected by the lifetime allowance. This is because members may have pension savings under schemes provided by previous employers. Trustees should therefore make generic information about the lifetime allowance available to their members so that the members themselves can decide whether the lifetime allowance is relevant.