Lock in protection now for pensions

The taxman could end up getting up to £165,000 extra from an individual’s pension fund unless action is taken now on protection.

On April 6, 2012, the lifetime allowance will be reduced by £300,000 from £1.8m to £1.5m, with a 55 per cent tax charge on any excess benefits taken as a lump sum or 25 per cent if providing a taxable income.

By applying for fixed protection, both the £1.8m LTA and up to £450,000 (25 per cent of £1.8m) in tax-free cash entitlement can be protected, rather than the lower cash figure of £375,000 (25 per cent of £1.5m).

A fixed protection certificate can be obtained by simply completing form APSS227 (available on the HM Revenue & Customs’ website) and returning it to HMRC no later than April 5, 2012. There is no provision for late applications. The applicant’s name, National Insurance number, date of birth and address will need to be inserted and a declaration signed to say that the applicant does not have enhanced or primary protection. No valuation of pension funds will be required.

There is a downside, however, as no further benefit accrual is allowed after April 5, 2012. Under a money-purchase arrangement, this means no further contributions (by employee or employer) can be made after April 5, 2012. In a defined-benefit scheme, benefit increases must not exceed either the consumer price index or the rate of increase specified in the scheme rules on December 9, 2010, effectively stopping active membership after April 2012.

Should any benefit accrual occur, an individual has 90 days to inform HMRC that fixed protection will no longer apply, otherwise penalties will be imposed.
Other than purely to accept a transfer of existing pension rights, no new arrangements may be started.

Fixed protection will also be lost if a transfer is made to a non-registered pension scheme, an overseas scheme or to a DB scheme from a money-purchase scheme. Providing a pension credit (as the result of a divorce) is transferred to an existing money-purchase arrangement (but not a new arrangement), fixed protection will not be lost.

Any transfer to a definedbenefit scheme will generally cause the loss of fixed protection, as benefit accrual will occur.

Those with either enhanced or primary protection will not be adversely affected by the reduction in the LTA. While this is the case, they cannot apply for fixed protection but it is possible to revoke enhanced protection (providing primary protection was not also elected at the same time, as primary protection is non-revocable).

Primary protection required a fund value at A-Day (April 6, 2006) in excess of £1.5m LTA but active membership could be maintained.

Conversely, with enhanced protection, fund values could be under £1.5m but benefit accrual had to cease, so anyone who expected to exceed the LTA would have been best advised to seek this protection and cease benefit accrual.

An individual could find himself or herself in a position where they have this protection with a fund under the current LTA of £1.8m. They could consider now revoking enhanced protection and (with added possible availability of the carry-forward facility) top up their pension fund prior to April 2012, then apply for fixed protection.

As the next time the LTA is not due to be reviewed by HM Treasury until 2016 (and there are no guarantees it will increase), where does that leave those who are expecting to exceed the new lower £1.5m LTA?

Those affected by the LTA reduction need to ask themselves:

  • Do they stop contributions/benefit accrual before April 5, 2012 and apply for fixed protection?
  • Do they do the above after making a large contribution (possibly using the carry-forward facility)?
  • Do they retire before April 5, 2012 (under the current LTA of £1.8m)?
  • Is the remaining 45 per cent (after the 55 per cent tax charge) better than nothing, if the employer is making most or all of the contributions?
  • Do they delay taking retirement until after 2016 in the hope that the next Government will lift the LTA significantly?
  • The clock is ticking, so urgent action now is crucial.

Example 1

Bill is 60 and has a deferred defined-benefit pension scheme with an expected benefit of £65,000 a year, which amounts to £1.3m (£65,000 x 20) for LTA purposes. He also has a Sipp arrangement valued at £100,000, bringing the value of his benefits to £1.4m.

He currently has enhanced protection and expects to take his benefits within the next few years. Due to the enhanced protection, he has not had any benefit accrual since 2006.

As his earnings during the current tax year allow, by utilising carry-forward he can make contributions of up to £200,000 into his Sipp without any annual allowance charge, so he decides to revoke enhanced protection, make the contribution and apply for fixed protection before April 6, 2012.

A couple of years later at age 62, when his fund is very close to the £1.8m fixed protection limit, he decides to take all his benefits but continues working until 65.

But he has one further pitfall to watch out for, as his employer has an auto-enrolment staging date of February 1, 2014. His employer will auto-enrol him into its qualifying pension scheme on this staging date and this process will be repeated every three years. He will also be auto-enrolled if he starts working for another employer whilst under the state pension age. He will have one month to opt out of the pension scheme (and therefore will be treated as though he has never been a member), otherwise he will lose his fixed protection.

Example 2

Ben is a member of the NHS pension scheme and also has a bit of a dilemma. He is 58 and intended to retire at 60.

He is able to take early retirement immediately with an actuarially reduced (but escalating) NHS pension of £46,200 a year and a £144,632 tax-free lump sum and he also has a Sipp valued at £400,000.

His total pension benefits amount to £1,468,632 (£46,200 x 20 + £144,632 + £400,000), well within the current £1.8m LTA.

His adviser has calculated that his NHS pension at 60 will be £54,687 with a £164,062 tax-free lump sum, with a projected Sipp value of £460,000. So, in two years time, his pension benefits are expected to be £1,717,802 (£54,687 x 20 + £164,062 + £460,000). This is well above the reduced £1.5m LTA resulting in a potential £119,791 tax charge at 55 per cent on £217,802 (1,717,802 – £1,500,000).

Does he stop accruing benefits in the NHS scheme and apply for fixed protection while continuing to work? Does he take early retirement? Does he continue accruing benefits and face the LTA tax charge when he eventually retires?

This is not an easy decision but one he needs to make very soon.