The lifetime allowance (LTA) is not new news. It was introduced in 2006 and has now become a fundamental part of our pensions’ landscape. So why are we still talking about it?
Initially introduced at a level of £1.5 million, it rose in value annually reaching £1.8 million in 2010, before starting its steady descent to its current level of £1 million from April 2016. Whilst in 2006 it was intended to catch the wealthier pension clients, the reduction has now created a situation in which its impact is being more widely felt.
The LTA tests the value of all the pension benefits held by an individual and includes the total of all the pensions held, including the value of pensions promised through any final salary schemes an individual belongs to. It may also include any payment made from an employer in the event of death in service. It does not include, however, State pension benefits.
Whilst most employees may not be affected by the LTA, it is important to remember that pensions are a long-term commitment for many employees, and what may appear to be a modest pension pot today could create a situation with contributions and investment growth where the LTA may affect members in the future.
Employers will only be aware of the value of the staff pension scheme. Older employees may have significant pension pots elsewhere. Despite the reduction in the LTA, there is in fact no limit on the value of pension savings that can be built up. However, if it exceeds the LTA when the pension is taken, the amount in excess of the LTA will be subject to a tax charge. Protection can help, but not everyone will qualify.
Nicola is an active member of the staff pension scheme. This is a money purchase scheme and it has a value of £200,000.
She also has a defined benefit pension with a previous employer, which has a paid up benefit of £26,000 per annum. For testing against the LTA, we multiple this pension by 20 (after checking that the scheme requires a multiple of 20). This gives us a value of £520,000.
This is currently below the LTA of £1 million.
Nicola does not qualify for Individual Protection 2016 (IP16) as her fund value as of April 2016 is below £1 million and she does not qualify for Fixed Protection 2016 (FP16) as she is continuing to contribute to the staff pension scheme.
Suzy has a pension of £30,000 per annum that she receives from her previous employer. She took the benefits in 2004, but although she is in the current staff pension scheme, she has not drawn any additional benefits since 2004.
When she retires from the staff pension scheme, the pension being paid before April 2006 is tested against the current LTA. To do this, we multiply the current pension (not the starting pension) by 25. This gives a notional value of £750,000 and uses up 75% of the available LTA of £1 million.
This would leave 25% (£250,000) of the LTA available to Suzy. Suzy’s staff scheme money purchase pot is £300,000. LTA charges would apply on £50,000.
However, Suzy can apply for IP16 as her fund value as at April 2016 was more than £1 million. Her protection will be the value of the funds as at April 2016, subject to a maximum of £1.25 million. If Suzy has not made contributions since April 2016, she may also qualify for FP16, which would give her fund protection up to £1.25 million.
- Are close to or over the LTA of £1 million as at April 2016
- Are in receipt of a pension that was in payment before April 2006, who have not yet tested them against the LTA
- Have large death in service benefits
- Andy Dickinson, Senior Consultant, July 2016