UK: Fixed Protection For Pension Savings - Do I Need To Take Action Before 5 April 2014?

The purpose of this guide is to assist in identifying individuals who may be affected and outline possible courses of action.

Lifetime allowance

The lifetime allowance was introduced in April 2006 and is the limit against which an individual's pension arrangements must be measured.

Examples of when pension funds are measured against the lifetime allowance include when taking benefits, on death prior to drawing benefits, transfer to an offshore pension, and at age 75, if a lifetime annuity has not been provided.

On 6 April 2012, the value of the standard lifetime allowance was reduced from £1.8m to £1.5m with a further reduction to take effect on 6 April 2014 to £1.25m.

To compound this problem, the Government has not indicated when this limit will next be reviewed, if at all.

Anyone who has previously elected for 'primary' or 'enhanced' protection will remain unaffected by the changes in the standard lifetime allowance. The new limit will also not apply to those who elected for 'Fixed Protection 2012' as £1.8m will continue to be used for the basis of those calculations but dependent upon growth and timescale, it will potentially affect everyone else with a pension fund.

Tax charges for exceeding the lifetime allowance

The changes to the standard lifetime allowance represent a reduction of over 30% in the value of pension benefits an individual may accrue.

Pension benefits in excess of the lifetime allowance attract a tax charge of either 55% if these are taken as a lump sum or 25% if they are used to provide an income which would then be subject to income tax.

As a result of the reduction in the lifetime allowance, we anticipate more and more pension savers will gradually be drawn into this tax net.

Fixed protection 2014

In recognition that individuals may have already accumulated pension funds in excess of £1.25m or expect to, it is possible for individuals to elect for 'fixed protection 2014' with HMRC by 5 April 2014.

This preserves the previous lifetime allowance of £1.5m. Funds in excess of £1.5m will still attract tax charges but, potentially, electing for fixed protection could save an individual up to £137,500 in tax on excess pension funds between £1.25m and £1.5m.

In order to register for fixed protection, individuals will have to stop pension contribution after 5 April 2014 and generally cease to accrue further benefits in their employer's pension scheme.

Individual protection 2014

For those who have accumulated pension funds in excess of £1.25m on 6 April 2014 and who wish to continue to contribute into pensions either now or in the future, or to accrue future benefits within an employer's pension scheme, HMRC will introduce a personalised lifetime allowance through 'individual protection 2014'. This personalised limit will be based upon the value of an individual's accrued pension benefits as at 5 April 2014. This will be set between £1.25m and £1.5m, according to the pension value at that time. Future benefit accrual will be permitted but any funds in excess of the personalised lifetime allowance will still be subject to the lifetime allowance tax charge.

It will not be possible to register for 'individual protection 2014' until later in 2014, when the window for applying for 'fixed protection 2014' has closed. This is because individuals will need to obtain values of their pension benefits as at 5 April 2014. It is proposed that a three year window will exist for 'individual protection 2014' elections until 5 April 2017. Final legislation is still being drafted but it should be possible for those who have elected for fixed protection 2012 or 2014 to also register for 'individual protection 2014'. Where dual protection exists, fixed protection will take precedence. It is therefore important to ensure any election for 'fixed protection 2014' is made before the deadline of 5 April 2014.

Will I be affected?

If the total value of your pension benefits currently exceeds £1.25m or is close to this limit and you have not previously taken steps to protect your pension funds, you are likely to be impacted by these changes.

However, even if your pension savings are below the £1.25m mark right now, it is quite possible for someone in their 30s or 40s to have amassed pension savings of over £1.25m by the time they retire.

The table shows how many years it would take for a pension fund to exceed £1.25m assuming no further contributions are paid.

Each time that you crystallise a new pension benefit you use up part of your lifetime allowance.

Individuals who are currently receiving income through pension drawdown may have already had the value of their arrangements assessed against the lifetime allowance but this will be subject to a further test at age 75 and therefore consideration still needs to be given as to whether fixed protection is required.

What action do I need to take?

You should initially consider when you expect to have finished crystallising your pension benefits.

It is then imperative that individuals collect information on all of their pension investments which have typically built up through various providers and different employers. This is likely to take some time and it is essential to start the process now to avoid the possibility of losing out.

Consideration should also be given as to whether the value of an individual's pension investments has been temporarily depressed as a result of market volatility and there is a danger of underestimating the potential future value.

How are my pension benefits valued?

Certain pension benefits may have a deemed value that is not immediately apparent.

Money purchase (defined contribution)

The value of money purchase funds, such as defined contribution occupational schemes and personal pensions, are applied directly against the lifetime allowance.

Final salary (defined benefit)

For final salary schemes, the annual pension amount is multiplied by a factor of 20 and any additional tax-free pension commencement lump sum is added to determine the value.

Lifetime pension annuities in payment

Pension annuities commencing after April 2006 will already have been valued against the lifetime allowance leaving a reduced limit to be applied against future benefits. You should have received notification of the amount of lifetime allowance that has been used from your annuity provider.

For pensions that came into payment prior to April 2006, the current annual pension amount is multiplied by a factor of 25 to establish the value to be applied against the lifetime allowance when further pension benefits are taken.

Income drawdown

For drawdown arrangements that came into payment prior to April 2006, the maximum Government Actuary's Department limit is multiplied by a factor of 25 irrespective of the actual level of income taken from the arrangement.

Income drawdown arrangements commencing after April 2006 will already have been valued against the lifetime allowance. However, if a lifetime annuity has not been purchased prior to age 75, a further test against the lifetime allowance will be applied.

What should I do?

There are three key ways to take advantage of the current higher lifetime allowance.

1. Individuals can elect for fixed protection for funds up to the current lifetime allowance of £1.5m. This election must be made by 5 April 2014 and individuals must stop pension contributions and cease accruing further benefits under their employer's pension scheme.
2. Individuals aged 55 or more may consider starting to draw benefits before 6 April 2014, while the lifetime allowance is still £1.5m.
3. Make additional contributions before 6 April 2014 and then take up one of the options above. Given that individuals may now attract tax relief on contributions up to £50,000 in the current tax year and, in addition, may be able to carry forward unused contribution allowances from the previous three years, maximising contributions now and then electing for fixed protection or taking benefits may prove valuable for high earners.

Potential pitfalls

In order to qualify for fixed protection, no further pension contributions can be paid or new benefits accumulated.

The decision as to whether or not to register for fixed protection may not be straightforward, particularly for those who are members of generous employer-sponsored schemes. Members of defined benefit schemes would have to opt out of future accrual, which is not a step to be taken without detailed consideration.

The potential tax penalties of exceeding the lifetime allowance need to be weighed up carefully against the value of future pension benefits being given up and the cost of replacing these. It may be necessary to re-negotiate employment contracts so advanced planning is essential.

For individuals who have registered for fixed protection, care also needs to be taken that this is not inadvertently affected by auto-enrolment in an employer's pension scheme in the future.

Auto-enrolment has been phased in for employers since 1 October 2012 and ultimately will oblige all employers to automatically enrol all employees aged between 22 years and state pension age with earnings equal or greater than the personal allowance into a pension scheme and pay contributions on their behalf. Individuals who have previously registered for fixed protection will only have one month to opt back out of the pension scheme before their fixed protection is revoked.

Many death in service schemes are also written under pension scheme rules. Individuals opting for fixed protection can remain a member of an existing death in service scheme if they joined prior to 5 April 2014, but would lose fixed protection if they joined a scheme after this date, unless the cover is provided under an excepted group life scheme, or a relevant life policy.

How do I apply for fixed protection?

HMRC will accept online applications from individuals wishing to apply for fixed protection 2014 directly via their website or paper applications on form APSS228 which can be requested or downloaded online from HMRC.

It is important to note that whichever method is adopted, all applications must be received by HMRC on or before 5 April 2014.

We have taken great care to ensure the accuracy of this publication. However, the publication is written in general terms and you are strongly recommended to seek specific advice before taking any action based on the information it contains. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. © Smith & Williamson Holdings Limited 2013. 13/1114 Code exp 30/06/14