Lifetime time allowance and the age 75 tests

One of the key technical areas that appears to cause confusion are the age 75 tests. Age 75 is the last point at which benefits will be tested and the latest any LTA charge can be deferred to and so is a crucial point for anyone with LTA issues.

There are three tests, known as Benefit Crystallisation Events (BCEs), that can occur at age 75.  As with all BCEs that occur during the member’s lifetime, the member can choose the order of the events where more than one applies. 

The first, BCE 5 applies where someone reaches age 75 without drawing all of their entitlement to their defined benefit scheme benefits.   This one is rare as most people will take their defined benefits by the scheme’s normal retirement date or if later, when they stop working, which is usually before age 75.   Where is applies, the normal defined benefit valuation methods are used ie 20 times the annual pension entitlement at that point plus any separate tax free cash entitlement.  

The important point is that any defined benefits already in payment before age 75 do not face a second LTA test at the age of 75.  There is a separate test, BCE3 if there is a significant increase in benefits outside of the normal annual increases but no automatic test on reaching age 75.

The second test at age 75 BCE5A looks at any funds that are still in drawdown.  From the current value of the drawdown funds you deduct the amounts that were first placed into drawdown through BCE1.  This test therefore considers the increase in the value of the drawdown funds. Any drawdown income taken between first crystallising and age 75 can therefore reduce any LTA charge. This means that the amount tested is within the client’s control.  However, there may of course be downsides to taking the income, particularly if it isn’t needed, such as high marginal rates of income tax and the funds increasing the value of the client’s estate for inheritance tax purposes.

The final potential test, BCE5B applies to any uncrystallised money purchase funds.  This is one that is becoming increasing common, particularly among those who are likely to exceed the LTA, as they choose to defer any tax charges to the latest point.   The test is simply applied to the value of the funds that remain uncrystallised at that point.  These funds then become known and unused funds.  Any tax-free cash entitlement can still be paid post 75 and for the purposes of calculating the entitlement, the BCE5B at age 75 is ignored.  This means that the client may essentially retain the right to the tax-free cash entitlement they could have taken from the funds before age 75.  However, an important caveat to that is you do not ignore the benefits tested at BC5C detailed above.  This can mean where there are both uncrystallised and crystallised drawdown funds the tax-free cash entitlement may reduce if tax free cash is deferred beyond age 75.

For those clients who have not taken their tax-free cash entitlement it is important to review this as the client approaches age 75.  Any tax free cash entitlement is lost on death as all benefits become taxable.  As with drawdown income above, there may still be a good reason for not taking it such as to ensure the funds remain outside of the client’s estate.

The charge

The LTA charge that applies at the point of the age 75 tests is always 25% on the excess above the LTA.  This is because no funds are withdrawn from the pension.  In nearly all cases the provider will deduct the tax charge from the pension, pass this to HMRC and adjust the benefits accordingly.  With money purchase funds it will be an equivalent reduction in the fund value.  With defined benefit schemes there will be an actuarial reduction in the value of the benefits to reflect the charge.  All the excess benefits can then only be taken as income and are subject to income tax.

The LTA problem appears here to stay and is likely to affect more and more clients.  A good understanding of both the detailed technical mechanics along with and the wider planning considerations are key to helping clients understand the impact