Play it by the rules

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Great in theory but in practice it was never going to be that easy. The government’s desire not to retrospectively penalise people meant that rules to protect existing funds would be needed, and so the idea of ‘protection’ was devised.

Now, with the further proposed changes to the lifetime allowance scheduled for 2014, there will be five different protection regimes, with the ability in some circumstances for them to double up.

As the 2006 rules introduced the idea of a lifetime allowance, the protection rules allowed the chance to protect values above the prescribed amount. Before we continue, let us just have a quick reminder of the rules as they stand.

Primary protection gives you an enhanced LTA, based on future increases to the standard LTA. It means you can have more pension savings without paying the LTA charge, while still being able to pay contributions. You could only elect for primary protection if you had built up pension savings of more than £1.5m on 5 April 2006, and the application needed to have been made by 5 April 2009.

Individuals who applied for primary protection should have received a certificate from HM Revenue & Customs showing their LTA enhancement factor.

There was also the option of applying for enhanced protection to avoid paying the LTA charge, but a number of conditions came with enhanced protection.

It was possible to apply for enhanced protection even if the capital value of pension benefits was below the LTA at 5 April 2006.

It was designed for those members who believed that their pension fund, or growth in its value, would mean that it would be worth more than the LTA. If a person applied for enhanced protection they normally could not pay further pension contributions to a registered pension scheme or accrue benefits under a defined benefit scheme.

It is possible to lose or give up enhanced protection. If this happens then HMRC must be notified.

Those who applied for primary and enhanced protection will have a certificate showing that they have enhanced protection. Enhanced protection has precedence over primary protection. This means that, following any loss or revocation, HMRC will send a primary protection certificate.

The LTA gradually increased to £1.8m by 2010/2011 but from 6 April 2012 it was reduced to £1.5m. Fixed protection allowed individuals to retain an LTA of £1.8m so that there would be no LTA charge for pensions up to this level. Fixed protection 2012 has similar conditions to enhanced protection – namely the requirement for cessation of contributions and accrual. Registration for this protection had to be made prior to 6 April 2012. It was not possible to have fixed protection in addition to either primary or enhanced protection.

From 6 April 2014 the LTA will be reduced to £1.25m and, surprise, surprise, a couple of new forms of protection are on the cards.

Fixed protection 2014 protects an individual’s LTA at the current level of £1.5m.

Individual protection is not expected to be available to those with primary or enhanced protection, and people will need a fund of at least £1.25m to register. It gives the ability to protect an LTA of up to £1.5m, depending on the value of pension schemes on 5 April 2014. The big difference is that ongoing contributions and extra accrual are allowed.

While fixed protection 2014 must be claimed by 5 April 2014, individual protection will only be available from the date of royal assent of the relevant finance bill, which is next summer.

For many people it would make sense to apply for both fixed protection 2014 and individual protection,. This would give them an LTA of:

• £1.5m if no contributions are made and no accrual occurs after 5 April 2014, or

• Their total benefit value (between £1.25m and a £1.5m cap) as at 5 April 2014 with contributions/accrual still possible.

In this article I have not had a chance to consider scheme-specific tax-free cash protection to protect entitlements of greater than 25 per cent pension commencement lump-sum, or the opportunity to use protection to protect entitlements to lump-sums of more than 25 per cent of the LTA – all of which are important and need to be considered.

All forms of protection apply not only to funds being accumulated, but also to funds in payment, and it is important to ensure that someone who has partially crystallised benefits knows what percentage of LTA has been used and therefore what remains. This can be affected by the level of LTA that has been protected.

All in all, for anyone who already holds, or will register for, any of the protection regimes, some complicated calculations may need to be done, including some reliance on calculations to show how much LTA has already been used.

I also think there are practical issues of having such a regime that has introduced different component parts during a number of years. For example, in a few cases I have assisted advisers who were recently appointed to advise clients, and my first question to them has been: Does the client have protection? The answer has been unsure, with certificates not found.

It is important that clients understand what they are doing and the implications of their actions.

One story told to me (which may or may not be true) was of a client who had a fund of some £4m at A-day. He was rightly advised to apply for enhanced protection, which he duly did, ceasing contributions accordingly. Thinking that he no longer needed pensions advice, he also ceased his adviser relationship. A new adviser was appointed a couple of years later only to find that the client was now paying £100 a month into a personal pension – a move that had invalidated his enhanced protection.

I have only really been able to focus on defined contribution schemes and not touched on the complications of DB. Many DB scheme members could face LTA issues without even knowing it.

This is an area where advisers can add real value by understanding the complexities of the rules and also making sure that decisions made today are carried through until the next benefit crystallisation event.

Mike Morrison is head of platform marketing for AJ Bell