City Trustees - part of Mattioli Woods

News and Media

28 February 2014

Fixed protection 2014: the need for advice

As the Government continues to seek new and different ways of squeezing ever more money out of a creaking fiscal system, tax efficient pension schemes now appear to be on the agenda.

The introduction of the Lifetime Allowance (LTA) in 2006 meant that, suddenly, members with large pension funds could be liable to a tax charge of up to 55% on any excess over the LTA when they crystallised their benefits.

The reasoning seemed simple; the Government wished to reduce the amount of tax lost through what had been very generous tax reliefs and exemptions and, since its introduction in 2006, we have seen a gradual erosion of the LTA down to £1.5m in 2012 and, with effect from April 2014, to £1.25m. Individuals are understandably not keen on a portion of their hard earned pension pots, which have often been strategically built up to the maximum levels, suddenly being hit with a tax charge as high as 55%.

Because of this, various types of pension protections have been available. These can involve complicated formulas, working out protection factors that are applied to an individual's share of the fund, or by simply fixing the maximum tax efficient amount an individual can save.

Fixed Protection 2014 involves fixing an individual's LTA at £1.5m prior to the reduction in April 2014. This amount is applicable to all of a member's pension pots and means that the member can continue to grow their funds up to £1.5m as opposed to the new £1.25m limit without the worry of tax charges. However, the following conditions do apply to Fixed Protection 2014:

1) A member cannot receive contributions or relevant benefit accrual within a registered pension scheme
2) A member cannot join a new scheme, except under special circumstances
3) Not all pension transfers will be allowed

These additional conditions mean that there are far wider issues to consider than one may initially think. For example, if a member applies for Fixed Protection 2014 but does not opt out of their employer's scheme, auto-enrolment scheme or joins a new group life arrangement, this could invalidate a members protection status. Whether intentional or not, if a member loses their protected status, HM Revenue and Customs must be notified in order to avoid penalties.

Protection could be in place for a lifetime and covers all of a member's pension pots, however small they are. Consideration needs to be given to assets held which could dramatically increase in value, leading to the LTA being breached. One example is property, where values may have been depressed during the credit crisis but could be a lot higher now.

Consideration may also need to be given to clients with pensions that were in payment before 5 April 2006 and still have uncrystallised rights. The first Benefit Crystallisation Event after 5 April 2006 required these pre A-Day rights to be notionally valued. For example, a defined benefit scheme paying £50,000 p.a. that came into payment before 5 April 2006 would be notionally valued at £1,250,000 (50,000 x 25) if a BCE occurs in 2013/14. As the LTA in the 2013/14 tax year is £1.5m; that would represent 83.33% being utilised. However, if it fell into the 2014/15 tax year in which the LTA falls to £1.25m, this would see 100% of the LTA being used.

Members who have been contributing regularly or have been receiving contributions from their employer and now have significant funds may well find that protection is beneficial. However, equally, this means they, or a company, would lose the tax benefits of making pension contributions, so may lead to increased taxation personally or for the company.

In addition, would opting out of a pension scheme mean an employee may lose other benefits that are conditional on pension scheme membership? In some cases, is protection too big a price to pay?

Overall, there is no one-size-fits-all approach, but clear guidance is needed for all affected individuals. Post protection, regular reviews will be essential to ensure that retaining protection is still beneficial and that the fund continues to perform despite the constraints of fixed protection. This will allow an individual to, hopefully, avoid excessive tax charges and ultimately maximise their retirement income. The deadline to apply for Fixed Protection 2014 is this April and should be taken seriously by all clients (not just those with larger funds) since the decision whether to protect or not is far from straightforward.


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