Because of their advantageous tax status, the UK government have always taken steps to limit the tax privileges available to an individual through a pension. There have always been limits on contribution levels and, in 2006, they introduced the Lifetime Allowance (LTA).
This limits the amount of pension benefit that you can take from your UK-based pension scheme without triggering an extra tax charge.
The Lifetime Allowance for the tax year 2020/21 is £1,073,100 and could increase in line with inflation at the end of the current tax year.
For defined contribution (DC) schemes, which includes personal pensions and most employer sponsored arrangements, the calculation is based on the overall value of the amount drawn from your pension fund
For defined benefit (DB) schemes, also known as “final salary schemes”, the calculation is based on 20 times the value of the income taken from your pension scheme.
How benefit crystallisation events work
When benefits are drawn from a UK-registered pension scheme in the form of tax-free lump sums or income, these events are known as “benefit crystallisation events” (BCEs). The Lifetime Allowance test is done each time you access such a benefit.
BCEs also occur when a fund is transferred overseas to a qualifying recognised overseas pension scheme (QROPS), when the transfer value will be tested against the Lifetime Allowance.
This is particularly relevant to people in Australia with retained pension benefits in the UK. The different tax regimes around pensions in the two countries mean that an individual could get tax relief on contributions in the UK, and then transfer it to an Australian scheme (via a QROPS) where they can take all the fund tax free. A transfer to Australia can attract a separate tax.
Is your current pension value near or above the LTA?
You should therefore look to act if the value of your UK pension benefits is approaching, or above, the Lifetime Allowance.
You should also bear in mind that, as pensions are normally a long-term commitment, what might appear relatively modest today could exceed the LTA by the time you want to take your benefits.
For example, with a net growth rate of 5%, a pension valued at £700,000 would take just eight years to exceed £1 million.
So, you should keep a close eye on the value of any UK-based pension funds, to avoid your benefits exceeding the Lifetime Allowance, especially if you are ultimately planning to transfer to a QROPS.
Taxation of amounts in excess of the LTA
If, despite any enhancement, your UK pension entitlement is still over the LTA, you will face a tax charge based on the excess value. The way the charge applies depends on whether you receive the money from your pension as a lump sum or, alternatively, as part of regular retirement income or transfer overseas.
Any amount over your Lifetime Allowance that you take as a lump sum is taxed at 55%. Your pension scheme administrator should deduct the tax and pay it over to HM Revenue and Customs (HMRC), paying the remaining balance to you.
Any amount over your Lifetime Allowance that you take as a regular retirement income – for instance, by buying an annuity or claiming a scheme pension – attracts a Lifetime Allowance charge of 25%. This is on top of any tax payable on the income in the usual way.
If an overseas transfer amount is in excess of the relevant Lifetime Allowance, a Lifetime Allowance charge will be levied. As the payment is not directly to the member the rate charged is 25%, not 55%, despite the fact it involves a lump sum.
Protections that allow you to exceed the LTA
There are different protections in place to enable individuals to exceed the Lifetime Allowance in certain circumstances.
To obtain greater protection against the tax charge, you can apply for “Individual Protection 2016”, which will afford you the Lifetime Allowance protection of your fund value as of 5 April 2016 up to a maximum of £1.25 million.
You also have the option to apply for “Fixed Protection 2016” which, as the name suggests, fixes your Lifetime Allowance at £1.25 million.
Non-Residence Enhancement Factor
This applies if you have worked outside of the UK and had an active UK pension scheme.
HMRC understood that some overseas individuals may well have not been eligible to receive UK tax relief while building up a UK pension benefit. They also knew that there were individuals who transferred an overseas pension into the UK without them getting tax relief on their contributions.
Therefore, HMRC created a special Lifetime Allowance enhancement factor that eligible individuals can apply for.
As well as being able to apply for Lifetime Allowance protection in the UK through HMRC, you could be eligible for the Non-Residence Enhancement Factor. This could be applied to the Lifetime Allowance for your pension if you were still an active member of a UK scheme whilst working in Australia.
It is available to individuals who have worked as a “Relevant Overseas Individual” at any time since 6 April 2006, and whose employers have been making contributions to a UK pension.
This protection is particularly relevant to people in Australia with a UK pension fund.
The Non-Residence Enhancement Factor is based on the increase in value of your pension, working in Australia from 5 April 2006 to the date you left the relevant scheme.
The calculations to determine your eligibility are not straightforward, and we strongly recommend that you seek financial advice concerning this issue.
How we can help
Lifetime Allowance calculations can be complex. Get them wrong or make a poor decision regarding your UK pension arrangements, and you could be faced with an unexpected and unwelcome tax bill.
We have extensive experience in helping people move their pension arrangements from the UK to Australia, so we are in the best position to advise you and ensure that any transfer is made as smoothly and tax-efficiently as possible.
Get in touch if you’re concerned about how the Lifetime Allowance could impact on your retirement planning.