With so many different variations to consider, lifetime allowance (LTA) protection is now a complicated area of the pension rules. Curtis Banks’ pension technical manager Jessica List provides a summary of the key features of each type of protection
Fixed protection (2012, 2014, and 2016)
The simplest form of LTA protection has three versions, for each of the three occasions the standard LTA dropped. The protection works by allowing the holder to keep the outgoing standard LTA for that particular year. For example, in 2012 when the standard LTA dropped from £1.8m to £1.5m, fixed protection 2012 holders kept an LTA of £1.8m. All LTA and tax free cash (PCLS) rules apply to the holders as normal, but with their protected LTA instead of the standard LTA at the time.
It’s possible to lose fixed protection, normally by accruing new pension benefits or joining a new pension other than to receive certain types of transfer. A full list of ‘cessation events’ can be found on online resources such as HMRC’s Pensions Tax Manual.
Fixed protection 2016 is still open for new applications, as long as the person hasn’t completed a cessation event since 6 April 2016 and doesn’t already hold primary, enhanced, or an earlier form of fixed protection.
Individual protection (2014 and 2016)
Individual protection works by giving the holder an LTA based on the value of their pension rights on either 5 April 2014 or 2016. There are specific rules for valuing pension rights for this purpose. The pension rights needed to be worth more than the new incoming standard LTA in that year, and the maximum protected amount was the old outgoing standard LTA for that year. For example, in 2014 when the standard LTA dropped from £1.5m to £1.25m, individuals needed pension rights worth more than £1.25m to apply, and the maximum protected LTA they could get was £1.5m. All LTA and PCLS rules apply to individual protection holders as normal, but using their protected LTA instead of the standard.
Individual protection can only be lost or revalued if the holder is subject to a pension debit on divorce.
Individual protection 2016 is still open for new applications for those whose pension rights were worth more than £1m on 5 April 2016 and who didn’t already hold primary protection or individual protection 2014.
Primary protection
This was one of the original forms of LTA protection from A-Day (6 April 2006), and is arguably the most complex. Individuals received a ‘primary protection factor’ which works as a multiplier to increase the LTA. The factors used to multiply the standard LTA, but since 2012 have been applied to an ‘underpinned’ LTA of £1.8m so that primary protection holders aren’t disadvantaged by the drops in the standard LTA. For example, if someone had a factor of 0.5, their original LTA in 2006/07 when the standard LTA was £1.5m would have been:
£1.5m + (0.5 x £1.5m) = £2.25m
Since 2012, their LTA has been:
£1.8m + (0.5 x £1.8m) = £2.7m.
Primary protection holders will normally have unusual PCLS entitlement. Some will have that entitlement built into their primary protection, which gives them a monetary protected PCLS amount. Otherwise, primary protection holders are subject to the normal PCLS rules, except that their entitlement is based on (another) underpinned LTA of £1.5m instead of the standard LTA. This helps ensure holders don’t have lower PCLS entitlement than they would have had at A-Day. If you have a client with primary protection it’s worth exploring full details of how these PCLS rules work, to ensure it’s been factored into the client’s retirement plans.
Primary protection can only be lost or revalued if the holder is subject to a pension debit – although it’s worth noting that the revaluing works slightly differently than the method used for individual protection.
Enhanced protection
This was the second form of A-Day protection, and works differently from any other type. Rather than increasing the holder’s LTA, enhanced protection simply exempts the holder from paying LTA charges. It’s easy to think this means enhanced protection holders never have to think about the LTA but unfortunately this isn’t the case. Enhanced protection holders are still subject to the standard LTA and all related rules and requirements (such as completing benefit crystallisation events and reporting the results); they just don’t have to pay any resulting charges.
Enhanced protection can also include PCLS protection, which is expressed as a percentage. That percentage would apply to all of the holder’s pension benefits with no upper limit based on the lifetime allowance. Enhanced protection holders without PCLS protection are in the same position as those with primary protection: they have normal entitlement but based on an underpinned LTA of £1.5m. However, because of the requirement to have some LTA available in order to take PCLS, enhanced protection holders can sometimes ending up losing the additional entitlement if they crystallise their pension benefits in stages. Again, if you have clients in this position it’s worth fully exploring these rules.
Enhanced protection can be lost if the holder undergoes any cessation events, which are similar to those for fixed protection. Full details can be found on resources such as the Pensions Tax Manual.
Enhancement factors
Last but not least, there are a range of enhancement factors available for clients who have funds that don’t need to be tested against the LTA. For example, the funds might have come from a pension credit and had already been tested against the original holder’s LTA, or the funds might have been accrued in an overseas scheme that didn’t receive UK tax relief. Enhancement factors work in a similar way to primary protection, acting as a multiplier to increase the holder’s LTA to account for the protected funds.
LTA enhancement factors do not increase PCLS entitlement. It’s possible for someone with an enhancement factor to run out of PCLS entitlement long before they use up their LTA. As enhancement factors can be held alongside other forms of protection, someone with an enhancement factor might still have unusual PCLS entitlement from elsewhere.
Enhancement factors normally have to be applied for within 5 years of the 31 January following the relevant tax year – for example, the tax year in which the pension credit or overseas transfer was received. They can’t be lost or revalued unless a mistake was made in the initial application.
LTA protection was among the most popular topics for technical queries we received during 2020, showing what a complex area it is and how many people are affected. Here we’ve touched on some of the key points, but it will be important to check the full details for any affected clients.
