Before looking at benefit crystallisation events, it is important to highlight the lifetime allowance. This is the maximum amount of pension benefits that can be taken from registered pension schemes before a tax charge applies. It used to be £1.8 million in the 2011/12 tax year, was then reduced over time down to £1 million and in the 2020/21 tax year the lifetime allowance is now £1,073,100. It increases each tax year in line with CPI.
Pension benefits held in a registered pension scheme will be tested against the lifetime allowance when:
- an individual chooses to take them
- death occurs
- age 75 is reached
- a transfer to a qualifying recognised overseas pension scheme takes place
These occasions, which each trigger a test against the lifetime allowance, are known as benefit crystallisation events (crystallising referring to when you start taking your pension benefits). We will cover the more frequent benefit crystallisation events that are encountered in our day to day work.
Taking pension benefits
Every time someone takes pension benefits, the crystallised value of their pension is measured (also known as ‘tested’) against the lifetime allowance in order to establish how much lifetime allowance has been used up by the crystallised value. The crystallised value for a defined contribution scheme (also known as a money purchase scheme) is the amount of the fund taken and for a defined benefit scheme, also known as a final salary pension, it is 20x the pension taken plus the tax-free cash.
An example of a benefit crystallisation event
Take Ben, who took benefits with a value of £103,000 in 2018 when the lifetime allowance was £1.03 million. On the assumption that Ben has not used any of his lifetime allowance, the scheme administrator issues him with a statement stating that he has used 10% of the lifetime allowance with this crystallisation.
If he crystallises more funds, he will be able to tell the scheme administrator that he has already used up 10% of the lifetime allowance. If his next crystallisation uses up another 20% of the lifetime allowance, he has now used up a total of 30% and will have 70% left to apply to his next benefit crystallisation event. The 70% will be applied to the lifetime allowance prevailing at the time of that benefit crystallisation event.
If he crystallises an amount that is more than the lifetime allowance he has left, the scheme administrator will ask him whether he wants to take the excess as a lump sum or whether he wants to use it to provide income. Not all scheme administrators will offer both options.
If he chooses a lump sum, a tax charge of 55% of the amount over the available lifetime allowance will be deducted by the scheme administrator and paid to HMRC with the balance paid to Ben as a taxed ‘excess lump sum’. This can be paid on top of the tax-free cash taken, but remember that tax-free cash is restricted to the lower of 25% of the fund and 25% of the lifetime allowance that is left.
If he chooses income, the charge will be 25% of the amount over the available lifetime allowance with the balance used to provide an annuity or a drawdown pension taxed as PAYE.
Benefit crystallisation events on reaching age 75
Some other benefit crystallisation events (BCE) happen automatically on reaching age 75. These are:
- BCE 5 – where someone reaches age 75 without having taken all or part of their defined benefit pension. The defined benefit pension is valued at 20x the full pension they would have received if they had taken benefits at age 75. The pension used is the pension the client would have received if they had not exchanged any of it for a tax free cash sum. However, if tax-free cash is provided separately (as is common in public sector schemes), that would be added in as a lump sum. The total amount is tested against the lifetime allowance available.
- BCE 5A – where someone reaches age 75 and is already in receipt of a pension from their pension fund which continues to be invested in the stock market at that age. A pension payable in this circumstance is known as ‘drawdown’. This BCE is triggered if there are still drawdown benefits to be paid out. The amount that is tested is the difference between the value of the fund at age 75 (i.e. the growth) less the amount originally crystallised. Clearly making withdrawals from the drawdown fund would result in a lower level of growth or no growth at all. However the withdrawals themselves will be liable for Income Tax, possibly at a 40% or even 45% rate, dependent on individual circumstances.
- BCE 5B – where someone reaches age 75 holding a money purchase arrangement without any or only some funds designated as drawdown pension. The uncrystallised fund is then tested against the remaining lifetime allowance available. Any lifetime allowance excess at age 75 is taxed at 25%; there is no option to take the excess as a lump sum.
An example of a benefit crystallisation event at age 75
Andrea crystallised her £200,000 pension fund on 1 October 2007, taking £50,000 tax-free cash with the balance of £150,000 going into drawdown. This used up 12.5% of the 2007/08 lifetime allowance of £1,600,000. On 1 October 2017 (her 75th birthday), the drawdown fund is worth £220,000. The £70,000 growth in the fund is tested against £875,000, which is 87.5% of the lifetime allowance in 2017/18, so no lifetime allowance charge is due.
After age 75 the only benefit crystallisation event that can happen is where a defined benefit pension in payment increases by more than a prescribed amount. This would be a rare occurrence, so for all practical purposes no benefit crystallisation event can happen after age 75.
Death before age 75 is also a benefit crystallisation event, so there is no escaping a lifetime allowance test. An individual’s pension rights will be tested at some point, but a lifetime allowance charge will only apply if the benefit crystallisation value is wholly or partly over the deceased’s remaining lifetime allowance available.
Evelyn Partners can help with your pensions
The lifetime allowance and benefit crystallisation events are clearly complex and areas where financial advice is wise. At Evelyn Partners we have a nationwide team of expert financial planners supported by pension technical experts. We offer free initial consultations so you can talk through your specific circumstances and find out how a financial planner can help you with your pensions and wider finances.
This article is based on our understanding of current legislation and is solely for information purposes. It is not intended to be, and should not be construed as advice. Whilst considerable care has been taken to ensure the information contained within this commentary is accurate and up-to-date, no warranty is given as to the accuracy or completeness of any information and no liability is accepted for any errors or omissions in such information or any action taken on the basis of this information.
Prevailing tax rates and reliefs depend on your individual circumstances and are subject to change.
This article was previously published on www.tilney.co.uk prior to the launch of Evelyn Partners.