Defined benefit (DB) pensioners with contracted out benefits could be facing an additional tax bill if their schemes opt to convert them after a recent court case.
In October, the High Court ruled that Lloyds bank scheme trustees must equalise benefits between women and men who have guaranteed minimum pensions (GMPs) because of contracted out benefits.
The ruling was considered a solution for a pension problem spanning almost three decades, and schemes are now having to decide how to equalise the contracted out benefits of their members.
One of the solutions is converting the GMPs into a normal scheme benefit which, according to Matt Davis, partner at Hymans Robertson, would make future administration easier for the pension funds and might be widely adopted.
But the problem with this solution, from a member's perspective, is that it will likely uplift the value of their pension, which could trigger an annual or lifetime allowance tax charge.
Even though the increase would be related to benefits accrued over a number of years, it could potentially fall in a single period for annual allowance, Mr Davis noted.
Currently set at £40,000, the annual allowance is the amount savers can contribute to their pensions each year tax free.
The problem could be even worse for those who have taken lifetime allowance fixed protection – which allows the member to protect the allowance from further reductions, but the saver can no longer contribute to their pension.
The lifetime allowance – the limit on the amount of money that can be saved in a pension without triggering a tax charge - currently stands at £1,030,000.
There are three fixed protections in place – one from 2012 at £1.8m; 2014 at £1.5m; and 2016 at £1.25m.
According to Andrew Boyt, independent consultant and pension transfer specialist, converting GMPs into normal benefits was likely to have a small impact on an individual basis, but the impact could be "critical for those at or near their fixed protection levels on current valuations".
He noted that individuals with the 2012 fixed protection were in the worst place, because £770,000 (the difference between £1.8m and the current £1.03m) could potentially be in the scope of the higher tax charges if the allowance threshold is broken and the protection effectively becomes void.
He said: "We’re are probably talking about a relatively small number of people, but the amounts involved could be quite significant, as they have tended to be the long serving high earners in DB schemes who have used the protection measures.
"The same will apply to annual allowance calculations, any additional accrual would be tested against the annual allowance and potentially provide an increased tax charge for the very high earners and long servers."
In its DB consolidation consultation published last week (December 7), the Department for Work and Pensions said it continued to work with HM Revenue and Customs (HMRC) "to investigate whether changes might be necessary to tax legislation for those potentially negatively affected by GMP conversion, as a result of benefit changes and corresponding lifetime tax allowance and/or annual allowance requirements".
Sir Steve Webb, former pensions minister and director of policy at Royal London, said the way pensions were tested against annual and lifetime limits contained "a number of anomalies".
He said: "On the face of it, converting GMP benefits into non-GMP benefits of equal value ought not to count as an accrual of pension benefits. But if the process increases your starting pension at retirement then that is exactly what could happen.
"HMRC need to engage actively with this issue both for GMP conversions that are ongoing and particularly ahead of the changes to pension rights which may follow from GMP equalisation. Without a concession from HMRC, thousands of people could be at risk of swingeing tax bills for no good reason."
maria.espadinha@ft.com
