£400,000 tax bill? Five ways you might lose a protected pension allowance
Estimated reading time: 5 minutes
Since its introduction in April 2006, the lifetime allowance (LTA) has effectively capped the amount of tax-relievable savings individuals can build up in registered pension arrangements. Savings above the LTA are subject to additional tax charges – designed to claw back the top slice of tax relief that would otherwise benefit the saver.
At its point of introduction, and again when the standard LTA was subsequently reduced by the Treasury, transitional arrangements were put in place to allow savers to protect benefits already expected to be above the higher LTA from the additional charges.
However, it is not just a case of registering once for these protections and then forgetting about them – as Nilesh Shah of our Executive Pensions team explains…
Background
The LTA has been part of the UK taxation landscape since 6 April 2006 (“A-Day”). It is the maximum total pension benefits at retirement that can qualify for beneficial tax treatment. Benefits paid in excess of the LTA are subject to an extra tax charge.
When it was introduced, those with pension savings already in excess of the allowance could protect those benefits from the new charges in one of two ways. When the LTA was subsequently reduced in later tax-years, savers could again protect benefits already valued above the new lower allowances.
Only the 2016 protections remain available to those who haven’t previously registered, the historic array of transitional LTA protections is as follows:
| Tax year | Lifetime allowance |
| 2006/07 | £1,500,000 (1) |
| 2007/08 | £1,600,000 |
| 2008/09 | £1,650,000 |
| 2009/10 | £1,750,000 |
| 20010/11 | £1,800,000 |
| 2011/12 | £1,800,000 |
| 2012/13 | £1,500,000 (2) |
| 2013/14 | £1,500,000 |
| 2014/15 | £1,250,000 (3) |
| 2015/16 | £1,250,000 |
| 2016/17 | £1,000,000 (4) |
| 2017/18 | £1,000,000 |
| 2018/19 | £1,030,000 |
| 2019/20 | £1,055,000 |
1
Primary protection
For those with benefits valued above £1.5m at April 2006. This value becomes the individuals personal lifetime allowance and is increased (in proportion) when the Standard LTA increases.
Enhanced protection
For those whose benefits were expected to exceed £1.5m at retirement. In return for ceasing “relevant benefit accrual” or contributions, individuals are shielded from LTA charges regardless of the value of benefits at "crystallisation" (e.g retirement).
2
Fixed protection (2012)
The individual with this protection retains a personal lifetime allowance equal to £1.8m provided no further accrual or contributions are made.
3
Fixed protection 2014
The individual with this protection retains a personal lifetime allowance equal to £1.5m provided no further accrual or contributions are made.
Individual protection 2014
The individual with this protection retains a personal lifetime allowance equal to the lower of £1.5m and the value of benefits at 5 April 2014 (provided it is at least £1.25m). Further accrual is permitted although tax charges may arise.
4
Fixed protection 2016
The individual with this protection retains a personal lifetime allowance equal to £1.25m provided no further accrual or contributions are made.
Individual protection 2016
The individual with this protection retains a personal lifetime allowance equal to the lower of £1.25m and the value of benefits at 5 April 2016 (provided it is at least £1m). Further accrual is permitted although tax charges may arise.
Putting these protections in place is not a once-and-for-all undertaking. The protections must be maintained and care must be taken not to fall foul of one of the many conditions that attach to those protections. In a manner of speaking, the protections must be protected.
In particular, 'relevant benefit accrual' which means to actually measure at the point benefits are taken rather than at the time the accrual occurs, or paying contributions into a personal pension will lose you your Enhanced Protection. Accruing benefits or making contributions at any time can invalidate your fixed protection (2012, 2014 or 2016 editions).
In the absence of alternative protections, you would then be subject to the standard lifetime allowance. This currently stands at £1.055m – some £745,000 less than the standard LTA at its peak in 2010/11, and the difference could be even more substantial where primary or enhanced protections were in place). As a result, you could be liable to pay a punitive 55% lifetime allowance charge on the now unprotected element – i.e. a bill for upward of £410,000 in unplanned taxes.
Five ways you could lose your protection
Sometimes “accrual” is not as obvious as having the payroll department divert your annual bonus into your personal pension. Here are five ways you might lose protection without even knowing… until it is too late.
- Automatic enrolment
- Transfers
- GMP equalisation
- Divorce
- Plain forgetfulness or human error.
These are outlined further below.
Since 2012 employers have been compelled to give access, and contribute, to a workplace pension arrangement. Opting-out is only permitted at the request of the individual. Moreover, companies must automatically ‘re-enrol’ staff into the scheme every three years, even if they’ve previously opted out.
It is therefore imperative those with enhanced or fixed LTA protections in place periodically check that they have not been re-enrolled into their employer’s pension scheme.
One possibility is to add a note in all auto-enrolment communication to state this could cause loss of any enhanced or fixed protection that may be in place.
There are some helpful relaxations from HMRC – notably individuals will not lose protections if they opt-out during a one-month period of grace after the (re-)enrolment has occurred. Furthermore, employers can legitimately chose not to re-enrol someone if they have “reasonable grounds” to believe they have a relevant LTA protection.There are restrictive conditions under which transferring your pension savings will not result in the loss of transitional lifetime allowance protections.
For instance, transfers can only be made from a defined contribution (DC) scheme to another registered DC scheme, or from a defined benefits (DB) scheme to a registered DC scheme - otherwise fixed protection (2012, 2014 or 2016 edition) will be lost.
The transfer value must also be “actuarially equivalent” to the rights being transferred and so any form of enhancement to the transfer value could result in loss of the LTA protection. In addition, a member could lose any form of fixed protection if they transfer their benefits to any of the following:
- an unregistered pension scheme or non-QROPS overseas scheme
- from a DC to a DB arrangement
- from one DB scheme to another (unless the transferring scheme is winding up or in certain corporate transaction scenarios).
Equalisation of Guaranteed Minimum Pensions (GMPs) is the topic du jour in the world of pensions (Brexit aside) and could result in backdated uplifts for many members of formerly contracted-out occupational pension schemes.
However, care is needed because these equalisation uplifts may yet attract tax charges resulting from loss of LTA protection. It all depends whether additional pension awarded is deemed to be relevant accrual.
HMRC is known to have set up a working group to investigate this further and it is hoped that a pragmatic solution can be found which will avoid disproportionate taxation arising from equalising GMPs. However, this may take some time to resolve – and in the meantime it may be best to play the waiting game rather than agreeing to an immediate uplift in benefits.For example, receiving pension credits into a DB scheme could result in loss of protection. As could setting up a scheme solely to receive a pension credit.
If benefits are to be shared in divorce proceedings, then some protections could be lost if you try to counteract the effect of a pension debit by increasing your pension savings. In fact, an individual’s LTA could be reduced by the value of the pension debit and so in some circumstances the impact could be magnified many times over.
We all make mistakes, but few would be as costly as accidentally forgetting not to breach the conditions attached to a protected LTA.
Proper planning will help, and although sometimes accidents can be overturned – it isn’t advisable to rely that this will apply in your case.
HMRC have historically taken the line that human error is not considered legitimate grounds for reinstating lost protections – although a recent ‘first-tier’ tax tribunal case (Gary Hymanson vs HMRC) resulted in fixed protection being restored for an individual who had forgotten to cancel a direct debit to his pension arrangements – and HMRC has since confirmed they will not appeal the ruling.
Prevention is better than cure. Individuals would be better to avoid being in Mr Hymanson’s situation in the first place by ensuring that advisers and employers are aware of the protections in place.
Lessons to learn
To summarise, there are three key actions you should take away in order to protect your lifetime allowance:
- Obtain expert advice from and IFA or a specialist tax and retirement planner. Our executive pensions team specialises on all aspects of annual allowance and LTA planning. For further information on the services we offer, see our website.
- Ensure that you have the appropriate protections in place, apply for Individual or fixed protection 2016 if appropriate. Other protections are generally now closed to new applications.
- Ensure your pension scheme managers and your employer’s HR department are aware you have protection in place and that pension contributions are not to be deducted if you have either enhanced or fixed protection. It is also advisable to periodically revisit these discussions.
HMRC has recently updated guidance on filling in the pensions sections of tax returns. However, don’t leave thinking about pensions taxation until it’s time to submit your annual tax return. By then it may be too late.
This blog post is intended as a broad summary of current taxation issues in relation to the pension Lifetime Allowance (LTA). Whilst we have taken care to ensure all information is correct at the time of going to press, no reliance should be placed on the content of this article as a basis for action or inaction when it comes to tax and retirement planning. In all cases guidance from an appropriately qualified adviser should be sought. Barnett Waddingham will not accept any liability whatsoever from individuals or entities who act on the basis of this article alone.