The lifetime allowance, the tax efficient ceiling for pension savings, will be reduced from £1.8 million to £1.5 million on 6 April 2012. To negate this, a new type of transitional protection known as ‘fixed protection’ is being introduced to help those with pension rights that already exceed, or are likely to exceed this reduced lifetime allowance.
Benefits above an individual’s lifetime allowance incur a tax charge of 55% if paid as a lump sum, or 25% if paid as an income, which itself is then taxable under PAYE rules.
Those who register for fixed protection, before the 5 April 2012 deadline, will have a personal lifetime allowance of £1.8 million, until such time (if ever) that the standard lifetime allowance increases above this level. It could therefore offer valuable tax breaks. However, the trade-off is that benefit accrual must cease after 5 April 2012; for money purchase pensions this means contributions must cease, and for final salary pensions the benefit value cannot increase by more than a ‘relevant percentage’.
Suitable contenders for fixed protection include:
- Anyone whose pension rights are already valued in excess of £1.5 million
- Anyone with pension rights currently valued below £1.5 million, but projected to go beyond this level in the future when they take benefits
- Anyone already taking benefits via drawdown pensions, where their total pension rights are likely to be in excess of £1.5 million at age 75
- Anyone who has already ceased pension funding, regardless of whether their pension rights currently valued close to £1.5 million
For those who have already stopped pension funding, the decision is simple. For those required to cease benefit accrual in exchange for fixed protection, careful planning and analysis is needed to establish whether this protection has the potential to provide greater tax-efficient benefits at retirement, when compared to the future funding (and tax relief) given up.
For active members of employer sponsored pension schemes, the decision is further complicated by the loss of future employer pension ‘contributions’. For many active final salary members, qualifying for fixed protection may actually require them to opt out of the scheme, which could also impact on other employee benefits contingent with pension scheme membership, such as death in service.
Fixed protection works best for those individuals without other forms of protection, who expect to finish taking their benefits, valued in excess of £1.5 million, in the short term. It may also help those with longer timescales, but the longer the timescale, the more difficult it becomes to evaluate any benefit of fixed protection on purely financial grounds.
Fixed protection is not available to individuals who have valid primary or enhanced protection, the protection mechanisms established in April 2006 when the lifetime allowance was first introduced.
- Individuals with primary protection have a personal enhancement factor which will continue to apply with an underpinned allowance of £1.8 million. They will consequently have no need for fixed protection.
- Those with valid enhanced protection will continue to be exempt from any lifetime allowance charge, provided this protection is not revoked or lost. Such protection also requires pension funding to have ceased.
- Many with enhanced protection will also have ‘dormant’ primary protection to fall back on.
- Only enhanced protection can be revoked in favour of fixed protection. This may be beneficial if there is no longer a requirement for protection of more than £1.8 million, and/or there is scope and justification for pension funding before 6 April 2012. In certain cases, fixed protection could also provide greater tax-free cash benefits than those available under enhanced protection.
The decision to register does not mean funding cannot restart at a later date, if circumstances dictate. Fixed protection can be revoked, but future assessment would revert to being based on the standard lifetime allowance. With the deadline for registration looming, if more time is needed it may be beneficial to register anyway. There is of course no guarantee that the standard lifetime allowance will increase in the future.
Fixed protection is not a one-off consideration. Anyone granted fixed protection should ensure their retirement plans are regularly reviewed to ensure it remains suitable, in light of the potential for changing circumstances, objectives and legislation. There are many issues that, without careful planning, could result in a loss of fixed protection, including:
- Pension transfers
- Divorce
- Automatic enrolment and NEST
- Monetary compensation in relation to a pension issue
It is worth remembering that even pension funds potentially liable to a lifetime allowance tax charge still benefit from exemption from inheritance tax and ring-fencing from bankruptcy proceedings.
This information in this article is based on our understanding of current legislation which may change in the future.