Individual protection from the lifetime allowance: what are the features and implications of IP14?

21 January 2014

Our pensions experts look at one new form of protection, called individual protection (or 'IP14'), currently under consultation.

Another reduction in the lifetime allowance, scheduled for April 2014, means another round of protections. The forthcoming reduction in the lifetime allowance (LTA) will mean that people who have planned their retirement savings by reference to the current £1.5 million LTA will need some form of transitional protection in recognition of that planning.

December 2012 saw the announcement that the LTA would be reduced from £1.5 million to £1.25 million, with effect from 6 April 2014 (the annual allowance will also be reduced on that date, to £40,000). This forthcoming reduction in the LTA prompted the announcement that 'fixed protection 2014' would be introduced. Under fixed protection 2014, the individual concerned will have an LTA of £1.5 million, but will lose that protection if there is any benefit accrual on or after 6 April 2014.

The possibility of a further form of protection was confirmed in last year's Budget. Following discussions with the pensions industry, a consultation paper issued by HMRC and the Treasury set out how a new individual protection would join the existing suite of protections from the LTA. Last month, HMRC published its response document as well as guidance for scheme administrators and draft legislation (in the form of the Finance Bill).

What will individual protection look like, how will it become available and what does it mean for schemes?

What will individual protection look like?

The idea behind individual protection (referred to as 'IP14' in the consultation document) is that people with pension savings above £1.25 million as at 5 April 2014 (but who are not already enjoying primary protection[1]) will have a personalised LTA, expressed as a monetary amount.

The consultation paper had originally proposed that people with enhanced protection[2] should not be eligible to apply for IP14, but the government then decided that IP14 should be available to those individuals providing that they do not also have primary protection on 6 April 2014 (the government accepted that it would be useful for individuals to also have IP14 to fall back on if enhanced protection were lost).

The LTA for a person with IP14 will be the value of their pension savings at 5 April 2014, up to £1.5 million (but if the standard LTA happens to be set at a higher figure at some point in the future then that higher figure will apply). People with IP14 will be allowed to continue pension saving after 5 April 2014 (this is not the case where fixed protection 2014 is used).

If the pension savings later drop to a figure below £1.25 million because of a pension sharing order on divorce, IP14 will no longer apply with effect from the date of the pension debit. If the pension debit reduces the personalised LTA to a figure above £1.25 million, however, then IP14 remains in place and that reduced personalised LTA will apply from the date of the pension debit. In that situation, the pension debit will be treated (for IP14 purposes) as reduced by 5% for each full tax year between 5 April 2014 and the date of the pension debit.

Individuals with pension savings above £1.5 million on 5 April 2014 will be able to apply for IP14 (again, they would not be allowed to apply if they have primary protection), in which case they will have a protected LTA of £1.5 million.

People with IP14 will also be allowed to enjoy fixed protection 2014 or fixed protection 2012 (a similar form of fixed protection to the 2014 version, introduced when the LTA dropped from £1.8 to £1.5 million in April 2012). People taking this route will be subject to fixed protection unless that is lost, in which event IP14 kicks in instead.

As regards any pension commencement lump sum, people with IP14 would be able to take 25% of their pension rights (subject to an overall cap of 25% of the personalised LTA).

How will IP14 become available and how will it be calculated?

People seeking IP14 will need to apply for the protection by 5 April 2017, using a form that will be available on HMRC's website (anyone applying for fixed protection 2014 will need to do so by 5 April 2014). Details about how to apply are set out in draft regulations accompanying the consultation.

Given that one of the conditions for IP14 is that the applicant must have pension savings above £1.25 million as at 5 April 2014, anyone seeking this form of protection must arrange for a valuation of their pension rights by reference to that date. The consultation paper proposed that the value of an individual's pension savings will be the sum of four things):

  • Pension savings in UK registered pension schemes that have not yet come into payment
  • Pension savings built up with UK tax relief that have already been tested against the LTA
  • Pension savings built up with UK tax relief that came into payment before 6 April 2006 (when the LTA was first introduced).
  • Pension savings with UK tax relief in overseas pension schemes that will be tested against the LTA.

The consultation paper contained detailed explanations of the valuation methods for the various types of pension savings (for example, uncrystallised rights would be valued using a method similar to that currently used by schemes when dealing with unauthorised payments, the hope being that the method will be familiar to scheme administrators already). Respondents to the consultation agreed that the valuation methods put forward in the consultation paper were broadly fair. HMRC's Guidance contains several examples of how to calculate an individual's personalised LTA under the IP14 regime.

For anyone wondering how IP14 and 'scheme pays' might interact (a 'scheme pays' arrangement is one where any annual allowance charge is met by the scheme on the member's behalf), the government response confirms that the member's personalised LTA would not be reduced by a corresponding amount (the government decided that it would be better to avoid the additional burdens that such an adjustment would have introduced).

What does this mean for schemes?

The LTA is, through its past (and most likely future) reductions, a cap on pensions tax relief of relevance to a growing number of people, so its impact will be felt more keenly by schemes having to deal with the fallout.

HMRC and HM Treasury's consultation paper acknowledged this fact and explained that IP14 would be introduced precisely because a wider population is less likely to pay for the financial advice that should be sought when weighing up the pros and cons of ceasing accrual (as required under fixed protection 2014). Giving that wider population the added option of IP14 would at least mean that the thorny question of a future accrual 'cliff edge' would not need to be contemplated by individuals likely to be affected by the LTA.

As well as familiarising themselves with the shape of IP14, trustees will need to make sure that their administrators become familiar with the Guidance issued by HMRC and build this new protection into their usual reporting requirements to HMRC.

Administrators may find that tweaks are made to the protection regimes in the future, however. A number of respondents had concerns about the extra burdens that the additional forms of protection would impose on scheme administrators, who have already been required to get to grips with the existing, complex, suite of protections. The government has acknowledged this concern and has promised that it will continue to work with the industry to minimise administrative burdens where possible. This may well result in future changes to the protection regimes, in recognition of any issues arising from the practical implementation of the various protections available (some of which are capable of applying in tandem).

What about schemes with no LTA charge experience? The forthcoming reduction in the LTA may well result in more people becoming subject to an LTA charge in the future. Schemes which have yet to deal with an LTA charge may not, therefore, have any systems in place to deal with that eventuality. It would probably make sense for schemes in that position to look at introducing such systems now.

While this alert is chiefly concerned with IP14, it is probably worth noting that some individuals will be applying for fixed protection 2014 (perhaps in addition to IP14 – as explained above, people applying for both protections will be subject to fixed protection unless that is lost, in which event IP14 kicks in). Employers of people seeking fixed protection are likely to face requests for compensation for the loss of the value of the employer's pension contributions. Employers considering any such requests will need to take care on a number of levels. Issues that would need to be examined in that scenario include: paying National Insurance Contributions on a salary supplement, taking care not to appear to incentivise the individual away from an auto-enrolment scheme (which would be illegal) and setting precedents which could undermine the employer's philosophy that it believes in pension provision for staff (as opposed to paying a higher salary instead).

What's next?

The Finance Bill 2014 provisions introducing IP14 are expected to receive Royal Assent this summer but the LTA protection provisions will come into effect retrospectively, from 6 April 2014. As people seeking IP14 have until 5 April 2017 to apply for the protection, this gap is unlikely to generate significant problems.

In the meantime, anyone applying for fixed protection 2014 will need to do so by the 5 April 2014 deadline.

Footnotes

[1] Primary protection (along with enhanced protection) was introduced when the LTA was first created in April 2006 because it was sometimes possible for a person to have tax-relieved pension savings worth more than the original LTA of £1.5 million. Broadly, primary protection gives an individual a personalised LTA based on the value of their pension savings immediately before 6 April 2006 and this would be an amount in excess of £1.5 million.
[2] Enhanced protection effectively freed the individual from the LTA charge provided that restrictions on future accrual were met. An individual could apply for both primary and enhanced protection at the same time, in which case enhanced protection took precedence and primary protection kicked in where enhanced protection was lost.


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