UK: Reduced Lifetime Allowance – Protecting Yourself From The Taxman

Last Updated: 30 December 2013
Article by Justin McGilloway

The Lifetime Allowance (the "LTA") was introduced by the Finance Act 2004. It places a cap on the amount of pension saving that an individual can build up over their life which benefits from tax relief. On 6 April 2014 the LTA reduces from £1.5m to £1.25m. The LTA tax charge (currently 55% for lump sums) is applied to all registered pension scheme benefits above the LTA. HMRC estimates that this change could affect up to 400,000 people – it is therefore important that individuals, employers and pension scheme trustees consider the effect of this change and what they can do to mitigate its impact.

What benefits are in scope for the LTA?

All registered pension benefits (including those from previous employments) count towards the LTA. Therefore, it may not be obvious to an employer which employees may be affected. The employer together with the pension scheme trustees will need to decide how much support to offer staff in dealing with their planning. Meanwhile, individuals should really be considering whether they may be likely to exceed the LTA either now or from 2014/15 onwards with regard to their entire relevant retirement savings.

In certain circumstances, payment of lump sum death in service benefits can also count towards an individual's LTA, meaning that the individual should consider the value of any such life assurance cover they have. For example,  an executive's four times death in service cover could easilyexceed the new LTA threshold if the value of all his registered pension savings is aggregated. These insured individuals will also need to consider the impact of future pay-rises as lump sum death benefits are nearly always based on a multiple of salary.

What happens when the LTA is exceeded?

When an individual dies and it is ascertained that the cumulative amount of the lump sum benefits payable from the registered pension scheme exceeds the LTA, the recipients of the lump sum benefits will be required to pay the LTA tax charge (55%) on the excess of the benefits over the LTA UNLESS the insured individual has some sort of protection in place.

What pension protections are available?

As with the last reduction of the LTA in 2012, transitional protections are available to allow affected employees to protect their existing pension accrual. Two forms of pension protection will be made available:

1)            Fixed Protection 2014

Transitional protection (known as Fixed Protection 2014) is available to assist individuals who have built up pension savings likely to exceed £1.5m when they take their benefits. This will allow such individuals to maintain a LTA of £1.5m and must be applied for by 5 April 2014. Such protection will be lost if the individual accrues further pension or makes further savings to their pension scheme after 5 April 2014. Loss of Fixed Protection 2014 means that the LTA tax charge will be payable on pension savings in excess of the new LTA.

 2)            Individual Protection 2014

 The Government has also announced that "Individual Protection 2014" will be available when the LTA is reduced to £1.25 million. This will allow savers with funds of between £1.25m and £1.5m to set a personalised allowance with HMRC.  They are not then subject to the lower LTA. The fine detail of Individual Protection 2014 will be confirmed later but crucially the individual will not lose Individual Protection 2014 by making further savings in to their pension scheme.

Individuals will be able to apply for Individual Protection from 6 April 2014 onwards.

A further concession for high earners... 

Until this week, savers with "enhanced protection1" – a form of protection first offered in 2006 – were prohibited from registering for the above protections. 

It was argued that it was unfair for those with enhanced protection to be excluded from the more flexible 2014 arrangement, as it could offer an extra buffer if they inadvertently broke their conditions for enhanced protection.

There were growing concerns that savers were at risk of losing their enhanced protection if they were automatically enrolled into a workplace pension, for example, or built up benefits above a set limit at any point before they retired. 

However, the Government has now reversed its policy, after responses to a consultation suggested that Individual Protection 2014 would be a useful fallback for individuals if enhanced protection was lost. 

This change represents a good outcome for those individuals, especially those with final salary benefits where the relevant accrual test that determines continued eligibility for enhanced protection may not be carried out for many years to come, when benefits are eventually crystallised. 

By registering for Individual Protection, those individuals with significant pension savings could take comfort from an underpin of between £1.25m and £1.5m before a LTA charge could be applied. 

The Government also confirmed this week that individuals who have lost enhanced protection since 2006 would be eligible to apply for Individual Protection 2014, providing they did not have "primary protection" on April 6 2014. 

Individuals likely to exceed the new LTA should take professional advice as swiftly as possible on the protection that best suits their circumstances.  The different deadlines for each type of protection, and rules on how each works should be considered in detail if individuals want to avoid a tax charge on funds exceeding the LTA after 6 April 2014. 

Footnotes

1.An individual could register for enhanced protection if the value of their pension benefits at 5 April 2006 exceeded the 2006/2007 lifetime allowance of £1.5million, or if they believed they might in the future exceed the standard lifetime allowance. Under enhanced protection you do not pay tax on benefits in excess of the lifetime allowance provided benefits at retirement do not exceed the value of benefits at 5 April 2006 as increased after then, in general terms in the context of defined benefits, by the greater of 5% per annum, the rise in the cost of living or increases in pensionable pay. 

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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