Updated: Feb 15, 2020
I specialise in helping individuals maximise their pension savings. Helping them understand potential ways of reducing tax on their pensions.
Jessica Cook LLB (Hons) DipFA ACSI
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The Lifetime allowance on UK pensions
The lifetime allowance is the total value of pension savings you can have before incurring a tax penalty on them. The allowance applies to all the pensions you have, including any defined-benefit (DB) or final-salary schemes, but excluding your state pension.
The lifetime allowance has reduced over the years down from 1.8 million to 1.5 million, down to 1.25 million, and it now currently sits at 1,055,000. Who knows where it will go next. It certainly seems to be a downward trend.
If the value of all your pension pots exceeds your lifetime allowance you will have to pay the lifetime allowance charge on the excess. You pay this when you take money out of your pension. If you don't take any pension benefits by age 75, at that point all uncrystallised pensions will be tested against the lifetime allowance.
The amount of tax you pay depends on how you take the excess. If you take any excess amount above the lifetime allowance as a lump sum it will be taxed at an eye watering 55 per cent. If you take it as income, for instance as drawdown, or by purchasing an annuity, it will be taxed at 25 per cent. And don’t forget that this is on top of income tax at your marginal rate.
But for those in the know and for those individuals who have been a member of a UK scheme while non resident, there is a clever way of saving yourself a significant amount of tax.
Ordinarily there are two main forms of lifetime allowance protection, that pension holders can utilise to try and increase their LTA. These are Fixed Protection 2016 and Individual Protection 2016. But there is also a much less well known form of protection called the Non Resident Enhancment Factor.
Before we look at how this works and whether you are eligible, lets cover off the standard forms of protection first: The rules pertaining to the successful application of Fixed Protection 2016 and Individual Protection 2016 are as follows:
Fixed Protection 2016
Fixed protection 2016 fixes an individual’s lifetime allowance to protect their pension savings at £1.25m after 5 April 2016 when the lifetime allowance dropped from £1.25m to £1m. For Fixed Protection it does not matter what the value of your pension pots are.
A condition of fixed protection 2016 is that in most cases you can’t pay into a pension pot anymore, except in limited circumstances. If you do, you’ll:
lose your fixed protection 2016 (you won’t if you opt out within 30 days of being automatically enrolled)
Pay tax on any pension savings above the lifetime allowance when you take your benefits.
Note that whether you can apply for Fixed protection also depends other forms of f LTA protection you already have.
Individual Protection 2016
Individual Protection 2016 is only an option for those with pension savings (including any pensions already in payment) of more than £1m on 5 April 2016. If your pensions are valued at less than this on this date, you cannot use this LTA protection.
People who apply for IP2016 will be given a protected lifetime allowance equal to the lower of:
Their pension savings at 5 April 2016, and £1.25m
The protected lifetime allowance will be quoted as a monetary amount and won’t change over time. If the SLA increases above the protected amount, the IP2016 protection would cease to apply and the higher SLA will become relevant.
It is important to note that unlike Fixed protection it is possible for those with IP2016 to make further pension contributions or accrue additional defined benefit rights after 5 April 2016. However, these additional pension savings are likely to be subject to a lifetime allowance charge when benefits are taken if they exceed an individual’s protected lifetime allowance (or the SLA, if higher).
The magic of the Non Resident Enhancement Factor
There is another form of LTA protection which can be used by those pension holders who are still, or were, active members of a UK scheme, while residing offshore. This LTA protection is know as an enhanced lifetime allowance. Specifically – A Non Resident Enhancement Factor.
Where as the above forms of lifetime allowance protection will only provide a max LTA of 1.25 million the Non Resident Enhancement Factor does not have a cap. So in theory your lifetime allowance could be protected up to a much higher figure. Saving you a significant amount of tax.
If you are one of the lucky people to have a large pension. Either as a fund within a defined contribution scheme, also known as money purchase scheme. Or as a final salary scheme and you have been an active member of a the UK pension while residing offshore, this form of protection could potentially allow you to have a protected LTA much higher than 1.25 million.
The non-resident individual’s lifetime allowance enhancement factor is available to individuals who after 5th April 2006 have been a ‘relevant overseas individual’ at any point in an ‘active membership period’ of a registered pension scheme. This typically happens when you work for a British company (or their subsidiary or related party) outside the UK.
The reason the Government offers this enhancement is to compensate individual taxpayers. Because those who are contributing to a UK pension scheme while working and being tax resident overseas typically don’t have access to the UK’s tax relief on pension contributions, as they pay income tax in a different country. Therefore it would be unfair to apply the Lifetime allowance to their pension savings.
The best part about the transitional form of LTA protection is that you can potentially increase your lifetime allowance to higher amount than if you were using fixed protection 2016 or Individual Protection 2016. With these two forms of protection the maximum protected amount is 1.25 million. So if your pension is valued at more than this you are still going to suffer the onerous tax on the amount over and above this protected amount.
So with the case of the non resident enhancement factor the longer you have been non resident while still an active member of a UK scheme, the better.
The calculation for the enhancement factor is provided in more detail below but broadly speaking you will be given a factor number by HMRC. This factor is then multiplied by the current standard LTA. So if for example you are given an enhancement factor of 0.95. Your new lifetime allowance would be the current standard lifetime allowance of 1,055,000 x 0.95 = 1,002,250. This amount is then added to the current standard LTA (Note it is whatever the. SLA is at the time) This would provide a figure of 2,057,25 0. This would be your new protected LTA.
An individual’s non-residence factor is calculated in accordance with Sections 222 and 223 of the Finance Act. The exact form of the calculation depends on the type of scheme and whether it is a defined benefit, defined contribution or hybrid scheme.
So, the important question – Do you qualify?
If you’ve spent time working abroad and were not resident in the UK for tax purposes, but you were contributing to a UK pension scheme, then you could qualify.
If you have been working for a British company (or subsidiary or related organisation) outside of the UK and, at the time you made your pension contributions, you were deemed to have been a “Relevant Overseas Individual”, then that would apply for the tax year as a whole and you would qualify.
However, you would only qualify if your were not residing in the UK and had no income subject to UK income tax and that you were not employed by a UK tax resident entity in any part of the given tax year.
If you qualifiy for a non-resident lifetime allowance enhancement, your lifetime allowance will be enhanced by a non-residence factor as detailed above. This is calculated by dividing the amount of contributions to, or accrual under, your pension arrangement during that part-period by the standard lifetime allowance for the tax year in which that part-period ends. and in relation to other money purchase schemes) the non-residence factor for each part of active membership during which the member is a relevant overseas individual is calculated as follows:
‘Establish the total amount of contributions made by or in respect of the individual to the other money purchase arrangement between the dates determined as follows:
The latest of the following dates:
• the date when the individual became a relevant overseas individual
•the date when benefits first began to accrue to or in respect of the individual under the other money purchase arrangement, and
• 6 April 2006.
• the earliest of the following dates
•immediately before the benefit crystallisation event,•the date when the individual ceased to be a relevant overseas individual, and
• the date when benefits ceased to accrue to or in respect of the individual under the other money purchase arrangement.
Express the resulting amount as a factor of the standard lifetime allowance as at the date under the second set of bullets above.
You can find out more about how the calculation works in HMRCS’s tax manual here
The claim for enhancement must be made no later than five years after the 31 January following the end of the accrual period. The end of the accrual period is the earliest of:
•immediately before a benefit crystallisation event in relation to the individual’s arrangement;
• the individual ceases to be a relevant overseas individual; and
•benefits cease to accrue to or in respect of the individual under the arrangement.
Points to note here are:
• the rule refers to accrual in respect of an arrangement, not a scheme; and
• it may be too late to wait for benefits to crystallise.
Separate notification is required for each arrangement and each period of active service overseas. After each notification, HMRC will provide a certificate showing the enhancement factor.
Please note that this entitlement is not automatic. You must notify HMRC using form APSS202. You should consult with a qualified financial adviser on how to do this and the best course of action.The online application for money purchase, defined benefit/final salary and hybrid schemes can be found here