Once in a lifetime
Prudential technical manager Les Cameron emphasises how not having protection from the lifetime allowance can severely hit pension wealth
During the summer, two events happened in the pensions world only a day apart.
On August 9, the First Tier Tax Tribunal published itsruling in the case of Hugh Scurfield v HMRC.
Scurfield had applied to HMRC for protection from the lifetime allowance in September 2010 but this application was refused as it was sub-mitted after the deadline of April 5, 2009.
An appeal was made as Scurfield claimed there was a reasonable excuse for the late submission.
He was retired and his adviser had passed away and he contended there was no reasonable way that he could have found out about the LTA changes.
The appeal failed as ignorance of the exact detail of the law was deemed not to be a reasonable excuse when it was widely known that those with large pension benefits could suffer tax charges if they did not have protection.
Due to an absence of protection, Scurfield’s LTA tax charge was about £65,000 rather than £35,000.
A day later, HMRC published the application form and guidance notes for fixed protection. Introduced by the Finance Act 2011, it protects those impacted by the reduction in LTA, effective from April 6, 2012.
The judgement is a timely reminder that LTA advice is crucial and can save those with sizeable pension benefits from suffering unnecessary tax charges.
The application for fixed protection
Applications must be received by HMRC before April 6, 2012. The forms are relatively straightforward. They cover the key eligibility require-ments for FP:
- Those with primary protection cannot apply
- Those with enhanced protection cannot apply unless it is revoked
The declaration includes the usual accuracy clause and confirmation that HMRC will be notified if protection is subsequently lost. Like its “big brother”, enhanced protection, FP will be lost if contributions are paid to money-purchase arrangements or if active membership of a defined-benefit arrangement continues after April 5, 2012. Increases for deferred members are acceptable within limits, as are some contributions.
There is also the opportunity to advise if benefits are being taken early in the new tax year so that the certificate can be received in time for that event.
Some nuances to be aware of around enhanced protection, include:
- The need to separately revoke enhanced protection by April 5, 2012 completing the FP form is not enough
- The fact that it applies from the date the revocation is received forward-dating is not allowed
- Paying a contribution would cause enhanced protection to be lost but notification of revocation is still required.
A final contribution can be made at any point this tax year. There is no need to stop at the time FP is applied for or granted. Employers need to submit or make contributions before April 6, 2012.
The FP form also confirms that where an applicant is auto-enrolled into a qualifying workplace scheme, under the new employer auto-enrolment obligations, they will not lose their protection if provided they opt out of those arrangements within a month.
Fixed protection and planning
At the back end of 2005, when A-Day loomed large, advisers were looking at their clients’ pension pots, contribution plans, asset allocations and LTA limits.
Now, as we build up to A-Day part two with a twist, instead of a rising LTA, there will be a standard LTA of £1.5m until 2015/16. Will it change sooner? Will it ever go back to or above £1.8m? We can only work with the information at hand and determine when and in what form clients will be taking their benefits.
Taking benefits in 2011/12 could be advantageous. Tax-free cash for a scheme member is broadly the lower of what the scheme will pay and 25 per cent of the unused standard LTA. When the LTA falls, so will the maximum TFC.
If cash is important, and vesting was planned in the near future, then it may be suitable to vest this tax year before the cash is restricted.
However, if income drawdown is used there will, as now, be a further LTA test at age 75 or the date of a later annuitisation. It might therefore be prudent to apply for fixed protection if vesting funds using drawdown.
Additionally, a pension pot which a client forgot about may appear in future, so an application “just in case” will do no harm.
Those planning to take benefits in the next one to five years face a theoretically simple but time-consuming job.
The value of benefits at a proposed retirement date should be estimated based on current planning.
Existing funds, contribution plans, asset allocation and estimated growth rate will need to be considered. Equally, for DB schemes, future accrual will need to be assessed, including salary assumptions.
Those expected to have benefits of less than £1.5m will not need FP. Those with benefits of more than £1.5m will suffer from tax charges if they do not have FP.
The sting in the tail is that contributions and benefit accrual must stop. There will, therefore, be a hole in retirement plans due to the loss of any future contributions. A single contribution can be made this tax year to plug the hole and/or fund up to £1.8m, relevant earnings and annual allowance permitting. Suitable alternate savings vehicles will need to be sought for money no longer being invested in the pension plan from April 2012.
Leaving a work pension scheme is a big decision and clients will need to be fully aware of the risks and understand the impact of doing so. However, a key point will be whether the payment of LTA tax charges would be accept-able to the client on the basis that the resultant net benefit is still worth what they are paying for it.
Who knows where the LTA will be after 2015/16? If funds are likely to be £1.5m or more, it may be appropriate to apply for FP having made a maximum single contribution this year and then building a non-pension “feeder fund” for later potential contributions if LTA allows and FP is no longer required.
Those with existing protection need advice on their TFC and LTA planning. Those with FP will have their TFC based on £1.8m, those with no cash protection will be based on £1.5m.
Scheme-specific protected TFC values remain the same. However, as the overall TFC maximum is restricted to a person’s available LTA, any reduction in LTA might see the TFC restricted unless they vest this year or opt for FP.
If those with primary or enhanced protection also have TFC protection, the amount will be on the protection certificate. These existing protections remain as it is. Where there is no TFC protection, the rules are the same as for everyone else they will therefore see a reduction in TFC if vesting does not occur prior to April 2012.
For those with enhanced protection only, this can be revoked allowing an application for FP. This leads to two key opportunities for advice.
First, if clients are planning to vest after April 5, 2012, then the TFC reduction above could be negated by revoking enhanced protection and applying for FP. This would probably only be suitable where enhanced protection is not req-uired to protect savings from future LTA charges, for example, if pension savings will be valued at no more than £1.8m.
If funds are expected to be no more than £1.8m, pension benefits can be boosted to £1.8m through a suitable single contribution made this tax year. Enhanced protection can be revoked and FP applied for. Care will be needed where TFC is already protected under enhanced protection some TFC available could be lost with this approach. Primary protection cannot be revoked so checking the impact on TFC if vesting beyond this tax year is key.
It is not always better late than never…
Most legislative changes come with the opportunities to improve people’s retirement planning as well as with potential threats to planning. As the result of Mr Scurfield’s case shows, the absence of protection when it is req-uired can severely damage pension wealth.