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Stewart ritchie on pensions

It is often said that the new pensions tax regime is not the simplification it is claimed to be but, in my view, most of the complexity is voluntary. People who embrace the complexity do so because it is in their interests. A prime example of this is enhanced protection for defined benefits (EP for DB).

Until a very late amendment to the Finance Bill, everyone thought that going for enhanced protection meant giving up future contributions (defined contribution) and giving up future accrual (defined benefit). The only known exemptions were contractingout rebates and contributions for life cover.

However, the Revenue had a last-minute change of mind. Its reasoning was along the lines of: “If we create a ringfence which increases after A-Day, why should we worry what part of the increase is used up by extra accrual and what part is used up by pension salary rises?” In fact, an extra dimension already exis-ted, namely the possibility that an early retirement reduction factor would come into play.

The bottom line is that clients who go for EP for DB can have further accrual after A-Day although if they do so, the situation needs to be monitored and managed. Look at Fred, a pre-1987 member.

At A-Day, Fred has 30 years of service on a 60ths scheme and earns 500,000. He registers for both enhanced and primary protection and wants to retire in 2016, 10 years after A-Day, when his salary is 600,000. RPI is 3 per cent a year for those 10 years.

At A-Day, his entitlement is 30/60 x 500,000 = 250,000 a year. So, to figure out what the “appropriate limit” is, we look at a two stage calculation.

Stage one – the A-Day entitlement increased by the greatest of RPI, 5 per cent, or a percentage specified in regulations – 250,000 x 1.05 for ten years = 407,223. Stage two – the pension using service to A-Day and final remuneration at retirement – 30/60 x 600,000 = 300,000 a year.

The higher of these two figures is the “appropriate limit” – 407,223. This is then checked against the actual benefit the scheme is paying.

If the scheme in this example used service after A-Day in the calculation of final benefits, it would pay 40/60 x 600,000 = 400,000. As this is below the “appropriate limit” of 407,223 the client has enhanced protection status and the benefits can all be paid without any lifetime allowance charge. In cases where the scheme benefit is greater than the “appropriate limit”, the client would lose enhanced protection but would still fall back onto primary (if registered).

The new leeway in EP for DB works best for pre-1989 members because later joiners have restrictions to pensionable salary in EP for DB. However, it is pre-1989 members where there is most at stake. The final rules applicable to EP for DB are highly complex but they offer an additional way of optimising pension benefits and tax efficiency for those affected.

Stewart Ritchie is director (pensions development) at Scottish Equitable

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