How to recover a Lifetime Allowance charge?

I was recently asked a question about a member who has already exceeded their Lifetime Allowance (LTA) and is about to take their pension under a Defined Benefit (DB) scheme.

The member’s full DB scheme pension entitlement is ￡3,633 p.a. so has a crystallisation value of ￡3,633 X 20 = ￡72,660 (assuming that the scheme has not agreed a factor larger than 20 with HMRC).?If this benefit is taken as scheme pension, the standard LTA charge arising would be ￡72,660 X 25% = ￡18,165.

So far, so good.

The unusual twist here, however, is that the scheme in question is intending to recover the charge from the member’s benefits not by applying a reduction to the member’s scheme pension entitlement but rather by withholding the member’s monthly pension instalments until the charge due has been recouped (which the scheme has estimated would take approximately 60 months to recover).

As my enquirer pointed out, this is a rather unusual approach to the recovery of a LTA charge, so we were asked whether there would be any issues with this.

Our view was that there are two immediate issues that would arise here. Firstly, the scheme appears to be taking the view that the member will become entitled to all of their scheme pension but the scheme will be imposing a lien against the member’s pension by withholding the pension instalments that should be due to the member until the LTA charge has been recouped.

Now, it is indeed possible for an occupational scheme to impose a lien against a member’s benefits, but only where the member owes money to the scheme arising from a criminal, fraudulent or negligent act or omission on the part of the member [Section 91 (5) (e), Pensions Act 1995].

In this case, it would not appear that the member has committed any criminal etc act – they have simply exceeded their LTA.?As such, the scheme would have no power to impose a lien against the pension payments due to the member.

Even if the member were to enter into an agreement with the scheme to allow the scheme to impose a lien against their benefits, such an agreement would not be enforceable by the scheme, meaning that the member could still demand their full benefits notwithstanding any such agreement [Section 91 (1), Pensions Act 1995].

Secondly, it appears that the scheme in question is not intending to actually reduce the member’s pension entitlement (the “whole of life” entitlement) to reflect the LTA charge that is due.?Instead, they appear to be intending to provide the member with their full pension entitlement without any LTA charge reduction, but hold back the first few years’ worth of instalments to recoup the LTA charge.

Under Paragraph 9 of Schedule 32 of the Finance Act 2004, where a scheme does not reduce a the member’s whole of life scheme pension entitlement to reflect any LTA charge that arises, the LTA charge that the scheme pays is deemed to be a “scheme-funded tax payment” under Section 215 of that Act. In this situation, the LTA charge due must be “grossed up”, as explained in the PTM starting here.

Applying this to the case in question, the annual rate of scheme pension is ￡3,633 p.a. with a crystallisation value of ￡72,660. As covered above, if the Scheme Administrator reduces the member’s whole of life scheme pension entitlement to reflect the LTA charge, the charge due would be ￡72,660 X 25% = ￡18,165.

Where a scheme funded tax payment is involved, however, the LTA charge itself forms part of the chargeable amount (the “grossing up” requirement), so the chargeable amount is calculated as ￡72,660 / 0.75 = ￡96,880 and the LTA charge arising would be ￡96,880 X 25% = ￡24,220.

In summary, schemes are very much expected to apply a whole of life reduction to the scheme pension to reflect any LTA charge arising and, if they do not do so, there are issues that will arise in terms of:

·????????The scheme’s power to recoup the charge by way of a temporary withholding of the member’s pension instalments, and?

·????????The requirement for the charge to be “grossed up” as it is viewed as being a scheme-funded tax payment.?

Whilst we can understand why a scheme may wish to adopt the approach suggested in this case, as it may provide a little more certainty that the scheme will fully recoup the charge due than an actuarially equivalent reduction to the whole of life pension offers, this is a case where the proposed work-around may well raise more problems than it solves.

Aries Insight?provides comprehensive and detailed guidance on the application of the Lifetime Allowance and the associated charge, as well as insight into the meaning and impact of UK pensions regulation and clear guidance on the practical implications for pension providers, trustees, administrators and consultants.?If you are not already an Aries member and would like to find out more about what Aries Insight can offer you, then please drop me a mail at [email protected] or give me a call on 01536 763352.

Please note that?we are not lawyers or financial advisers.?The information above sets out our best understanding of the legislation and how it applies, but should not be taken as constituting legal or financial advice.