With all the noise around fixed protection, the impact of recent lifetime allowance changes on A-Day protection has been neglected.
While the impact of A-Day protection on total pension size tends to be reasonably well understood, the effect of protection on tax-free cash is not as straightforward. Individuals who hold primary or enhanced protection who are expecting to take 25 per cent of their pension benefits as tax-free cash may well be disappointed.
Recap: A-Day lump sum protection
Where total lump sum rights on 5 April 2006 exceeded £375,000 (ie, they were greater than 25 per cent of the lifetime allowance, or LTA, at A-Day), individuals were able to incorporate lump sum protection within their application for primary protection and/or enhanced protection.
- For uncrystallised funds this was the value of lump sum rights as if the member had reached normal retirement age on 5 April 2006.
- For crystallised funds, lump sum rights were deemed to be 25 per cent of the notional capital value, which was 25 times the annual income at 5 April 2006. When in drawdown the annual income was deemed to be maximum Gad.
Crystallised funds are only considered to determine whether total lump sum rights exceeded £375,000. Only lump sum rights on uncrystallised funds can be protected under primary or enhanced lump sum protection.
Primary lump sum protection
Under primary lump sum protection the monetary lump sum entitlement on 5 April 2006 is increased in line with the LTA, but underpinned at £1.8m. Essentially, it is the value of uncrystallised lump sum rights at A-Day multiplied by 120 per cent. The lump sum will be limited by the available personal LTA.
Enhanced lump sum protection
Under Enhanced lump sum protection the percentage lump sum entitlement at 5 April 2006 is used as the personal percentage entitlement in place of the standard 25 per cent.
This may be lower than 25 per cent per scheme but the cash amount that can be taken tax-free will be uncapped.
No A-Day lump sum protection
It was not uncommon for individuals applying for primary or enhanced protection to be ineligible for protected tax-free cash because their total lump sum rights at 5 April 2006 were valued below £375,000.
For example:
- Defined benefit schemes may not have offered a default lump sum. Some schemes only provide for tax-free cash through commutation, in which case lump sum rights were deemed to be nil.
- Some defined contribution schemes could only offer lower or nil (for example protected rights) lump sum rights pre-A-Day.
- The application form was complex and some individuals may simply have failed to correctly value their lump sum for protection purposes. See Example 1.
Without primary or enhanced lump sum protection the individual is limited to the lower of 25 per cent of the fund and 25 per cent of the standard LTA. From 6 April 2014 the ‘standard’ LTA for this purpose has been underpinned at £1.5m. Previous benefit crystallisation events (BCEs) need to be revalued in line with the £1.5m underpinned LTA to assess how much remains available to provide tax-free cash.
Taking benefits post-April 2014
The reduction in standard LTA brings some anomalies in the calculation of tax-free cash where an individual holds primary or enhanced protection without lump sum protection.
LTA underpins were introduced to prevent those who hold A-Day protection being retrospectively disadvantaged by the unforeseen reductions in the standard LTA. However, the existence of the two underpins brings some inadvertent consequences.
Two separate calculations need to be undertaken - one to assess the personal LTA and one to assess the available lump sum.
This is best demonstrated with Example 2.
Phased retirement post-April 2014
The legislation introducing the £1.5m underpin applies it to all previous BCEs. Applying it to BCEs post-April 2014 will artificially increase the value of that BCE, because the standard LTA has now dropped to £1.25m. This means that phasing benefits post-April 2014 could further reduce the availability of tax-free cash. See Example 3.
By taking benefits in two tranches post-April 2014 he has reduced the available tax-free cash from £32,143 to £27,143.
All may not be lost; if it emerges that a member failed to correctly value the lump sum entitlement, it is possible to amend an existing protection form by sending Form APSS200 to HMRC. This amendment can make a huge difference to the tax-free cash entitlement today.
Scheme-specific lump sum protection
Scheme-specific protection applies to occupational schemes where the lump sum entitlement on 5 April 2006 was above 25 per cent. Primary and enhanced protection take precedence but in their absence, scheme-specific lump sum protection may apply.
Scheme-specific protection is not always evident as past salary and benefit records are becoming scarcer over time.
Scheme-specific protection is more common than primary or enhanced lump sum protection because there was no minimum fund value in order to be eligible. There are similar quirks in the calculation depending on whether fixed or individual protection is also held.
Summary
Where primary or enhanced protection is held without lump sum protection and the member is looking to crystallise funds:
- Check whether lump sum rights exceeded £375,000 on 5 April 2006.
- If so, amend the protection certificate to add in lump sum protection for uncrystallised funds.
- If an amendment is not possible, any pre-A-Day pensions might still benefit from scheme-specific tax-free cash protection
- If no lump sum protection is available, consider a single BCE to maximise tax-free cash.
Victoria Harman is technical support consultant at Hargreaves Lansdown
