On 10 June, HMRC and HM Treasury published a consultation on the detail of a system of Individual Protection from the LIfetime Allowance (LTA) charge for those affected by the reduction in the LTA from £1.5 million to £1.25 million in April 2014, specifically those whose pensions savings are already over, or close to, £1.25 million. The consultation closes on 2 September and final legislation is expected to be included in the Finance Bill 2014.
Fixed Protection 2014
The system of Fixed Protection is already available, introduced when the LTA was reduced from £1.8 million to £1.5 million. Fixed Protection 2014 will give individuals a fixed LTA of £1.5 million, on condition that the individual makes no further contributions to, or accrues benefit under, a pension arrangement that attracts UK tax relief. This form of protection is suitable for those people who expect their current pension savings to grow to more than £1.25 million because of investment growth between now and when they retire. It is likely to be of most interest to those who would be entitled to employer contributions to a pension arrangement but are able to negotiate an alternative benefit in lieu of those contributions.
Individuals wishing to use Fixed Protection 2014 will have to apply for it before 6 April 2014 but cannot do so until the relevant regulations come into force, which is expected to be shortly after the Finance Bill 2013 receives Royal Assent later this year.
Individual Protection 2014
Individual Protection 2014 (IP14) will give individuals a personal LTA equal to the value of their pension savings on 5 April 2014, subject to a maximum of £1.5 million. This valuation must include:
- pension savings in UK registered pension schemes that are not yet in payment,
- pension savings in UK registered pension schemes that are in payment, or have otherwise been tested against the LTA,
- pension savings with UK tax relief that came into payment before 6 April 2006 and
- pension savings with UK tax relief in overseas pension schemes.
The personal LTA will not be increased unless the standard LTA increases to a higher level, at which point the individual’s LTA will revert to the standard LTA.
For example, Anne and Brian have pension savings of £1.3 million and £1.4 million, respectively, on 5 April 2014 and they both apply for IP14. Anne’s personal LTA is £1.3 million and Brian’s £1.4 million. After some years the standard LTA rises to £1.35 million. Anne’s personal LTA would then be lower than the standard LTA, so she becomes subject to the standard LTA at that time. (There is no suggestion in the consultation as what would happen if the LTA were subsequently reduced again!) Brian’s LTA remains at £1.4 million, since this is still higher than the standard LTA.
It should be noted that this treatment is different from that applying to Primary Protection, in that the personalised LTA available under Primary Protection was expressed as a percentage of the standard LTA, so was increased automatically when the standard LTA was increased.
Individuals with IP14 will be allowed to make further contributions to, or accrue benefit under, a pension arrangement that attracts UK tax relief without losing Individual Protection, although they will have to pay LTA charges on those additional savings (55% on benefits taken as a lump sum and 25% on benefits taken as pension, payable in addition to normal income tax). Thus, for those in a defined benefit scheme, there will be no escaping the LTA charge because with IP14, even if one leaves active membership, since the amount of revaluation between leaving and retirement will be subject to the charge!
This form of protection results in a lower level of protection than Fixed Protection but HMRC and HMT consider it likely to be of interest to those who are entitled to employer contributions to a pension arrangement and do not wish to lose the benefit of those contributions.
Individuals wishing to use Individual Protection 2014 will have to apply for it before 6 April 2017 but cannot do so until the relevant regulations come into force, which is expected to be shortly after the Finance Bill 2014 receives Royal Assent (expected in Summer 2014). It will be possible for individuals to apply for both Fixed and Individual Protection 2014, as was the case with Primary and Enhanced Protection in 2006. (Those with Primary or Enhanced Protection will not be able to apply for IP14, although those with Fixed Protection 2012 will.) For an individual having both Fixed and Individual Protection, the Fixed Protection will take precedence (and provide a higher LTA). It will be only if Fixed Protection is lost that IP14 will be triggered, bringing the personal LTA into play.
When an individual with IP14 has a benefit crystallisation event he will need to present his IP14 certificate, that sets out his personalised LTA, to the scheme administrator, so that the calculation of the amount of LTA used by the event may be calculated correctly.
The Government proposes that the tax-free lump sum available to people with IP14 will be limited to 25% of their personal LTA.
Effect of Divorce
If an individual with IP14 gets divorced and the ex-spouse is granted a share of the pension rights, so the individual’s own pension savings are reduced by a pension debit, the personal LTA will also be reduced by the amount of the debit, preventing the individual from being able to rebuild his pension fund with the benefit of tax relief. However, if the application of the debit would reduce the personal LTA to less than £1.25 million (or the standard LTA at the time), IP14 will be lost and the standard LTA will apply. Thus the maximum amount by which a person’s LTA can be reduced as a result of a pension debit is (currently) £250,000.
This is a factor to be borne in mind at the time the financial settlement on divorce is being agreed, since it may become more tax-efficient overall for the ex-spouse to be granted other assets rather than pension if one party has IP14.
It is proposed that the reduction in the personal LTA be equal to the monetary amount of the pension debit at the time of the order, rather than expressing it as a percentage of the individual’s pension fund and reducing the LTA by that percentage. This differs again from the treatment under Primary Protection, where the reduction in the personal LTA reflects the percentage represented by the pension debit.
For example, Brian, with his personal LTA of £1.4 million gets divorced in 2020, by which time the value of his pension savings has grown to £1.7 million. The Court awards his ex-spouse 10% of his pension savings, so he suffers a pension debit of £170,000, reducing his personal LTA to £1.23million. This is less than the standard LTA, so he reverts to the standard £1.25 million.
If, however, IP14 were treated the same way as Primary Protection, Brian’s personal LTA of £1.4 million would be reduced by only 10% of that amount, to £1.26 million, so he would retain IP14.
Scheme Pays
“Scheme Pays” is an arrangement under which a pension arrangement pays the annual allowance charge on behalf of a scheme member and reduces his benefit under the scheme by an equivalent amount. The Government is proposing that such a reduction in benefit should also be applied as a reduction to the personal LTA, in the same way as a pension debit on divorce, although it should be noted that no such reduction to the personal LTA applies currently under Primary Protection.