About 100,000 savers could face a six-figure tax bill if they have contracted out benefits and their defined benefit (DB) scheme opts to convert them.
The issue stems from the Lloyds case in October when the High Court ruled that trustees of the bank’s pension scheme 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 DB 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. But the problem with this, 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.
According to a freedom of information request (FOI) from Royal London, more than 100,000 people have secured fixed protection against past cuts in the lifetime allowance for tax relief purposes.
This allows the member to protect the allowance from further reductions, but the saver can no longer contribute to their pension. If their pension changes due to GMP equalisation this could breach the protection.
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.
As Royal London pointed out if someone’s tax relief limit suddenly fell from £1.8m to the current £1.03m, they could face a 55 per cent tax charge on the difference – a bill of £423,500.
According to Sir Steve Webb, former pensions minister and director of policy at Royal London, this issue combines two of the more complex areas of pensions – GMPs and pension tax relief limits.
He said: "But that combination could result in a catastrophic tax bill for someone who had acted entirely in good faith.
"It would be absurd and perverse if a small and unrequested pension boost in response to a court judgment meant that a scheme member suddenly faced a huge tax bill.
"It is not good enough for HMRC and DWP to be discussing this issue and thinking about issuing guidance. Taxpayers need to know where they stand as a matter of urgency."
FTAdviser reported earlier this month that HM Revenue & Customs (HMRC) is aware of the problem and is considering the tax implications of the court case.
In its DB consolidation consultation published in December, the Department for Work and Pensions (DWP) stated it continued to work with 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".