The other main controlling influence is the lifetime limit. This limits the
amount of tax-privileged funds which the pension can contain at vesting (i.e.
the time when benefits are first provided to a member) – if the pension fund
grows to exceed the lifetime limit, tax will be charged on the excess.
The initial value of the lifetime limit is £1,500,000 as at 6th April 2006,
with annual increases in line with inflation.
Because the excess is taxable, the government does not propose to limit how
the member can receive it (unlike the tax-privileged sums within the lifetime
limit, where no more than 25% can be taken as a lump sum). If any part of the
excess is taken as a lump sum by the member, tax is charged at 55%; if any
part of the excess is used to provide a pension, the tax charge is 25%.
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Example
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Jocasta reaches retirement age and wishes to
take benefit from her pension. At that date,
the fund is £1,900,000 (assume the lifetime
limit is still £1.5M). Of the funds within the
lifetime limit, she is entitled to a tax free
lump sum of one quarter, or £375,000. The
remainder must finance pension income.
Jocasta has an excess of £400,000, which she can
decide how to apply. She decides to take
three-quarters of this as an enhancement to her
lump sum, and the remainder as part of her pension.
The scheme trustees are required to pay 55%
tax on the £300,000 lump sum element, so that
Jocasta receives a total lump sum of £510,000
(£375,000 tax free plus £135,000 after tax).
The trustees are required to pay 25% tax on
the £100,000 which is retained to provide pension
income. This means that a total of £1,200,000
(£1,125,000 within the lifetime limit plus
£75,000 of the excess) is available to fund a
pension – assuming annuity rates of around 5%,
this would generate an annual pension of c.
£60,000.
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