InvestmentsJul 27 2015

How to get a grip on pensions protection

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When the lifetime allowance was introduced in 2006 to cap all tax-relieved pension savings, we were led to believe it would increase for five years to £1.8m.

It would then be reviewed by Treasury Order and it was expected that the allowance would rise further.

This was clearly not to be. It did reach £1.8m but that cap was short-lived, and we are now awaiting a drop to £1m. But this may be in doubt, depending on the outcome of the Budget green paper on pension savings, which could remove or amend the lifetime allowance tests entirely.

The introduction of the allowance saw the start of the first two transitional protections of pension savings, with many more to follow.

Primary protection was available to anyone with pension benefits in excess of £1.5m, including those already in payment, and gave a multiple of the standard lifetime allowance. It did not place any restriction on contributions going forward, so an individual was able to remain an active member of a pension scheme.

It should be remembered that it isn’t possible to opt out of primary protection at any point.

Enhanced protection was available to anyone and offered full protection from lifetime allowance charges in exchange for not paying future contributions or having any relevant benefit accrual, which generally meant opting out of all pension schemes.

It was possible to hold enhanced and dormant primary protection at the same time. This gave the individual the option to rely on primary protection if they lose or choose to opt out of enhanced protection. Losing enhanced protection would occur if a contribution was paid or relevant benefit accrual occurred in excess of the permitted level.

In addition, it was possible to protect any pre-A-day (April 6 2006) tax-free cash entitlement alongside primary and enhanced protection if it was worth more than £375,000. Primary protection preserved a monetary amount, whereas enhanced protection safeguarded a percentage of the overall benefits.

When the lifetime allowance was initially reduced from £1.8m to £1.5m in 2012, a new type of protection came about called fixed protection, which secured the allowance at £1.8m for those that applied. It is similar to enhanced protection because of the restriction on future contributions and benefit accrual and the fact that anybody could apply for it.

It is again possible to lose the protection if an individual contributes or receives relevant benefit accrual. However, the test is slightly different for fixed rather than enhanced protection and means it could be lost at any point, even in a defined benefit scheme rather than just at transfer or crystallisation – or receipt – of benefits.

This was repeated in 2014 when the lifetime allowance dropped to £1.25m, protecting at £1.5m, and will again be available when it falls further to £1m in 2016, protecting at £1.25m.

Fixed protection always needs to be applied for before the actual decline in the lifetime allowance, so until fixed protection 2016 is available it isn’t possible to apply for this option.

It wasn’t until 2014 that individual protection became available. It is akin to primary protection because not only do you need a certain benefit level to apply, it allows those that have already applied to continue to contribute or accrue benefits. It is also not possible to lose individual protection.

Individual protection 2014 offered a personal lifetime allowance between £1.25m and £1.5m equal to the value of benefits on April 5 2014. It is possible to apply for this until April 5 2017 and will overlap with the application dates for fixed protection 2016 and individual protection 2016, if they come into force.

It has been proposed that individual protection 2016 will also give a personal lifetime allowance of between £1m and £1.25m for those with benefits valued in that region on April 5 2016.

It is possible to apply for individual protection if you have fixed protection of any kind or enhanced, but not if you have primary. The differing levels of lifetime allowances can cause confusion for many, especially if they are lost part way through taking a series of benefit crystallisations.

It is good that it is not necessary to go back and recalculate the amount used in each benefit crystallisation event if the protection is lost after the event itself, because it means the member should always be aware that there won’t be a retrospective tax charge.

Claire Trott is head of pensions technical at Talbot and Muir

Consultation: Pensions tax relief

In the summer Budget, George Osborne announced a green paper on pension savings that would seek views from the industry on the tax system for pensions. Closing on September 30 2015, the consultation paper states:

“It has been more than a decade since the government last reviewed the support on offer through the tax system for those saving into a pension. At the heart of the current system is a simple principle: the contributions you make to a pension during your working life are tax free, and you pay tax on them when you come to take your pension.

However, recent years have seen a substantial increase in life expectancy. With increased longevity and the changing nature of pension provision, the government needs to make sure that the system incentivises more people to take responsibility for their pension savings so that they are able to meet their aspirations in retirement.

If people are to take responsibility for their retirement, it is important that the support on offer from the government is simple and transparent, and that complexity does not undermine the incentive for individuals to save.

It is also vital that the system is sustainable. During the course of the last parliament, the government took action to control the growing cost of pensions tax relief through the lifetime and annual allowances. The state pension age was also raised to reflect the pressure placed on the public finances by increased life expectancy. These difficult but important decisions have helped put the public finances on a more sustainable footing.”