Robert I Fraser of Tax Insider outlines two possible forms of protection for pension funds following a reduction in the Lifetime Allowance.
Under the pension rules, the current Standard Lifetime Allowance is £1.8 million. The crystallisation of benefits in excess of the Lifetime Allowance is now subject to a tax charge of 55% if the excess is taken as a lump sum, or 25% if used to provide a taxable income. The Lifetime Allowance will be reduced to £1.5 million from 6 April 2012 until at least 5 April 2016, but how will this affect you and what can you do to protect your investment?
Panic not, as protection will come in two forms: the ‘Underpinned Lifetime Allowance’ and ‘Fixed Protection’.
Underpinned Lifetime Allowance
The ‘Underpinned Lifetime Allowance’ will be introduced on 6 April 2012 and will be defined as the greater of the Standard Lifetime Allowance for the relevant tax year and £1.8 million.
In this way, benefits currently due a level of protection will continue to be protected by substituting the Underpinned Lifetime Allowance for the Standard Lifetime Allowance. Current levels of protection will therefore remain in place and will increase as before, should the Standard Lifetime Allowance rise above £1.8 million at any point in the future.
The Underpinned Lifetime Allowance will mean that those with Primary and/or Enhanced Protection will not be adversely affected by the reduction in the Standard Lifetime Allowance from 6 April 2012.
For those with Primary Protection, the new Underpinned Lifetime Allowance will be used to determine their Personal Lifetime Allowance Enhancement Factor, rather than the Standard Lifetime Allowance. In practice this will mean that this Factor will be frozen at 20% (the percentage increase in the Standard Lifetime Allowance from April 2006 to date) until at least 5 April 2016 when the Government will undertake a further review.
Any pension commencement lump sum protected in conjunction with Primary Protection will similarly be increased by the increase in the Lifetime Allowance since April 2006.
The value of benefits protected by Enhanced Protection is not linked to the Lifetime Allowance and therefore will be unaffected by the change.
Individuals who have not previously registered for Primary or Enhanced Protection (following the original introduction of the Lifetime Allowance in April 2006) will be able to apply for a new type of protection known as ‘Fixed Protection’.
Fixed Protection will allow individuals to continue to utilise the current Lifetime Allowance of £1.8 million or a higher sum should any future Lifetime Allowance exceed £1.8 million. The following criteria will need to be met:
- No contributions to money purchase arrangements after 6th April 2012 either by the individual, their employer or by a third party.
- Defined Benefit annual accrual of no more than the Consumer Price Index (CPI) increase after 6 April 2012
- Individuals will have to register for Fixed Protection by 5 April 2012 using a standard HMRC form (to be published once the Finance Act receives Royal Assent). There are no provisions for late submissions after 5 April 2012. HMRC will issue a certificate confirming the Fixed Protection.