Defining moment for fixed protection
Phil Clarke, technical services manager at Rowanmoor Pensions, sets out the details on claiming fixed protection for a pension fund to avoid paying excess tax if the fund tops the new lifetime limit coming in next year
From April 6, 2012, the pension lifetime allowance will reduce from its current level of £1.8m to £1.5m.
The Government has recognised that members of pension schemes may have arranged their pension planning to achieve a fund of £1.8m by the time they want to take benefits. For these members, there is the opportunity to claim fixed protection which will allow them to build up a fund of up to £1.8m without suffering a lifetime allowance charge.
Members cannot claim fixed protection if they have claimed and want to retain enhanced protection or primary protection.
The size of the current fund is not relevant when making the application, although when benefits are taken, tax will be charged on the excess if the fund is over £1.8m but this new form of protection is lost if further contributions are made to a money-purchase scheme or further benefits are accrued in a definedbenefit scheme.
The rules for claiming fixed protection are as follows:
- No new contributions may be paid to a money-purchase arrangement after April 6, 2012
- A new pension arrangement cannot be established unless it is to receive a transfer of existing funds
- Applications must be made by April 5, 2012.
The form that needs to be completed to claim fixed protection is now available. To be valid, applications for fixed protection have to be received by HM Revenue and Customs by April 5, 2012. There are no exceptions and late claims will not be accepted.
There is therefore only a short period of time for IFAs to consider which of their clients may benefit from claiming fixed protection.
There are a number of different scenarios which need to be considered when deciding to apply.
First, are members aware of the current value of their SSAS or Sipp? It may be possible that a currently relatively lowvalue fund will exceed £1.5m when the member takes their retirement benefits.
Advice needs to be taken regarding fund growth assumptions. If growth does not match expectations, contributions can restart, although the fixed protection above £1.5m is lost.
Does the scheme hold any investments that may increase in value in excess of normal growth expectations? There could be higher than expected rental yields, land held as an asset of the scheme may have potential for development that may increase its value, or an investment in shares may have potential to increase considerably in value.
Finally, did the member claim enhanced protection and now realises that the scheme will not grow in value as anticipated? There is now the opportunity to make a contribution (perhaps using carry-forward) to bring the fund up to a level to achieve £1.8m. Although enhanced protection will be lost, fixed protection can now be claimed.
A trickier scenario is if the member did not claim enhanced protection and the fund has now grown to an extent that it will exceed £1.5m and possibly £1.8m or more at retirement.
If we assume that fixed protection is not claimed and the final fund value is £1.7m tax charges will be as follows:
- If the £200,000 excess is taken as pension income, the scheme will be subject to a tax bill of 25 per cent of the excess, that is, £50,000. The balance must be used to provide a pension.
- If the amount is taken as additional pension commencement lump sum, the tax bill will be £110,000, that is 55 per cent of the excess.
If fixed protection is claimed,there is a potential saving on the amount over £1.5m as there will be no tax bill and the £200,000 will produce an additional tax-free pension commencement lump sum of £50,000. If the fund increases to more than £1.8m, there will be a tax saving on the £300,000 difference although tax will be charged on the excess fund over £1.8m.
On a related topic, care needs to be taken by anyone who is a member of a scheme with pension protection who starts a new period of employment. If they are auto-enrolled into a new pension scheme, any contributions paid by an employer would cause the protection on their main scheme to be lost.
As a final point of illustration, I was recently approached by a client who did not claim enhanced protection. A piece of land which is held in his pension scheme is about to increase dramatically in value as it is to be sold to a supermarket chain. It is obviously too late to apply for enhanced protection but fixed protection will make the situation easier to bear.