On 6 April 2016, the standard lifetime allowance (LTA) will be reduced from £1.25 million to £1 million. This is part of a series of reductions since 2012. Here we set out an overview of the current protections, as a handy source of reference; a brief description of the new protections that are being introduced in 2016; and the practical steps which individuals and employers should now be taking.

The LTA is a limit on the amount of pension benefit that can be drawn from pension schemes - whether lump sums or retirement income - without triggering an extra tax charge. When it was first introduced on 6 April 2006, transitional provisions were put in place to protect those who had already accrued benefits that were above the LTA. Similar provisions have been established every time the LTA has been reduced.

This has resulted in a highly complex suite of available protections. The complexity is magnified because the details differ with each change, and because the protection is not automatic: members have to apply for it, and also there is often more than one form of protection for affected members to choose between.

Summary of the LTA changes and protections

Tax year Standard lifetime allowance Available protections
Before 2006/07 No LTA  
2006/07 £1.5 million Primary protection
Enhanced protection
2007/08 £1.6 million (No protections needed while LTA was increasing)
2008/09 £1.65 million (No protections needed while LTA was increasing)
2009/10 £1.75 million (No protections needed while LTA was increasing)
2010/11 to 2011/12 £1.8 million (No protections needed while LTA was increasing)
2012/13 to 2013/14 £1.5 million Fixed protection (also known as "fixed protection 2012")
2014/15 to 2015/16 £1.25 million Fixed protection 2014
Individual protection 2014
2016/17 to 2017/18 £1 million Fixed protection 2016
Individual protection 2016

How do the protections work? Key concepts

The detail of the protections is notoriously complicated, but the underlying principles are actually quite straightforward.

When the LTA was introduced in 2006, individuals who might be affected by it had the option of primary or enhanced protection, or both, or neither.

  • With primary protection, an individual whose pension savings already exceeded the £1.5 million LTA was given a personalised LTA based on the amount by which his savings exceeded the LTA on 5 April 2006. There may also be a further enhancement to the individual's LTA if a lump sum death benefit is paid in respect of him. There is no prohibition on accruing further benefit.
  • With enhanced protection, the individual was exempted from the LTA altogether and remains in the position he would have been in had the change not been made, i.e., had the LTA not been created. The advantage of this over primary protection was that even if his pension savings increased in value at a faster rate than the standard LTA, he would still not face an LTA charge. The price paid for this enhanced level of protection was that in order to keep it, he is not permitted to accrue any further benefits in a registered pension scheme (we will come below to what that means).

That underlying philosophy is retained through the subsequent changes.

  • Individual protection, available in respect of the 2014 and 2016 changes, gives the individual a personalised LTA based on his savings at the time of the change, as primary protection did. Note however that there was no individual protection option in 2012.
  • Fixed protection (in its 2012, 2014 and 2016 incarnations) is akin to enhanced protection in that it treats the individual as if the latest reduction to the LTA had not been made, i.e., as if the LTA were fixed at its previous level. In return, the individual cannot accrue further benefits in a registered pension scheme.

The above is, of course, a simplification: there are numerous and important differences between the forms of protection. However it is useful to have in mind for the purpose of understanding how the system works.

What protections are available?

The deadlines for applying for primary protection, enhanced protection, fixed protection 2012 and fixed protection 2014 have all passed, so these are no longer available for new applicants.

The deadline for applying for individual protection 2014 is 5 April 2017. It may be beneficial for some members to consider whether individual protection 2014 is preferential to fixed protection 2016 or individual protection 2016.

It is not possible to apply for fixed protection 2016 or individual protection 2016 before 6 April 2016 (because as part of their application, members must provide certain values and make declarations in relation to their pension savings as at 5 April 2016). HMRC is adopting a different approach to previous protection regimes: there will not be a deadline as such, but members will need to apply for a reference number before they draw their benefits.

That said, members will need to make key decisions before 6 April 2016, so the absence of a deadline is not a reason to delay taking action. HMRC intends to introduce an online digital service for applications, which will be available in July 2016, under which members will receive a permanent reference number. In the interim, for anyone taking benefits between 6 April 2016 and July 2016, there will be a process enabling members to apply for a temporary reference number. HMRC has produced a "pro forma letter text" for members to reproduce (essentially to ensure the member provides the correct information). It will be necessary to make a full online application though in July and receive a permanent reference number in order to retain the protection, although it is currently not wholly clear how this is intended to work.

What are the new protections?

The two new protections for the reduction in the LTA from £1.25 million to £1 million on 6 April 2016 are fixed protection 2016 and individual protection 2016.

We do not yet have final legislation for these protections; however, from information provided so far, they are not substantially different from the protections that were made available for the 2014 reduction to the LTA (fixed protection 2014 and individual protection 2014).

The key difference between fixed protection 2016 and individual protection 2016 is as follows.

  • Fixed protection 2016 fixes the individual's LTA at the level before the latest reduction, i.e. £1.25 million. In return for this, the individual cannot accrue further benefits in a registered pension scheme. If he does, the protection is lost. See below for more detail on this.
  • Individual protection 2016 gives the individual a personalised LTA based on the value of his savings at the time immediately before the LTA is reduced to £1m. See below for an overview of how this value is determined. There is then no prohibition on accruing further benefits.
  • In either case, if the standard LTA ever increases again such that the standard LTA exceeds the LTA the individual would have by virtue of the above protections, the standard LTA will apply.

It will be possible to apply for both protections, in which case, fixed protection 2016 will take precedence, but if it is lost, the individual will then fall back upon individual protection 2016.

How do benefits exceed the LTA?

Benefits are tested against the LTA when they "crystallise". The legislation contains a tightly-defined set of "benefit crystallisation events", but as a rough guide, benefits crystallise when any of the following happens.

Benefit crystallisation event Amount crystallised by the event
A DC pot is designated for drawdown or used to buy an annuity Value of the pot
A scheme pension is put into payment Annual pension (as at the date it comes into payment) multiplied by 20
A scheme pension in payment is increased, by more than normal indexation Increase to the annual pension multiplied by 20
A lump sum is paid Value of lump sum
Individual reaches age 75 with an uncrystallised DC pot Value of pot at age 75
Individual reaches age 75 with uncrystallised DB rights Annual pension that he would have received at age 75 if he were entitled to it, multiplied by 20
Payment of certain types of lump sum death benefit Value of death benefit. (Note that special provisions apply for members with primary protection.)

This is not an exhaustive list and is a simplification. Bespoke advice should be sought before relying on this.

Benefits that are over the LTA, taking into account any protection the individual may have, are subject to a special charge to income tax at 25% if taken as pension or 55% if taken as lump sum. Both the member (or, in the case of a death benefit, the recipient) and the scheme administrator (i.e. the trustees, in an occupational scheme) are liable to pay this charge, although it only needs to be paid by one of them. Schemes should therefore check that their rules allow them to pay benefits net of any LTA charge for which the scheme administrator may be liable.

When determining the value of a member's benefits for the purposes of setting his personalised LTA if he takes individual protection 2016, the following should be taken into account:

  • any benefits already crystallised as per the table above,
  • the value of benefits that have not yet crystallised, which are, in broad terms, treated as if a crystallisation event occurred on 5 April 2016,
  • an addition is made to take into account the value of any pensions that came into payment before the concept of a benefit crystallisation event was introduced on 6 April 2006, and
  • an addition is made in relation to any relieved non-UK pension schemes in which the member may have benefits.

How are protections lost?

Enhanced protection and the various forms of fixed protection are all lost if certain events occur - broadly speaking, if the member increases the value of their benefits in a registered pension scheme save for normal increases in the value of benefits already accrued.

In more detail, what that means is as follows (the legislation for each protection is slightly different, but the key principles are the same):

  • Any further contribution by the member or in respect of him to a DC pot in a registered scheme will cause a loss of protection.
  • Any further accrual of DB benefits in a registered scheme will cause a loss of protection.
  • Normal indexation of benefits already accrued does not usually cause a loss of protection. However, the way this carve-out is drafted in the legislation is complex and can be unclear, especially for members who benefit from unusual forms of indexation and/or revaluation - this is a point on which to take specific advice.
  • Creation of a new arrangement by or in respect of the member in a registered pension scheme will cause a loss of protection.
  • A transfer out from a registered pension scheme to a scheme which is not a registered pension scheme or recognised overseas scheme will cause a loss of protection.
  • Certain transfers into a DC arrangement may also cause a loss of protection, if the transferring arrangement was not a pension scheme or did not relate to the member, or if the amount being transferred in is a lump sum death benefit.
  • Continued provision of life cover through a registered pension scheme is a complex area and special advice should be sought. However, there are alternatives to registered pension schemes which provide comparable benefits and similar tax advantages to registered pension schemes, e.g. excepted group life policies.

Primary protection and the various forms of individual protection are not lost in the above circumstances. They can be lost on divorce, however, if a pension sharing order is made.

What should affected individuals and employers be doing now?

The legislation for the 6 April 2016 changes, and the 2016 protections, is still in draft form. Nevertheless, the policy intention is clear, and any individual who thinks they may be affected by the forthcoming reduction in the LTA should seek independent financial advice in advance of 6 April 2016.

Although there is no deadline for applying for either of the 2016 protections, it may be necessary to opt out of, or elect not to join, any registered pension schemes before that date. This is because fixed protection 2016 is automatically lost (or cannot be obtained) if further benefits accrue in a registered pension scheme on or after 6 April 2016 - see above for the circumstances in which protection may be lost.

Employers should also be considering how to communicate the change to their employees. In doing so, they must be careful not to give financial or tax advice if they are not qualified to do so. The LTA is an income tax issue for the individual, and it is for the individual and his own advisers to consider how to mitigate any exposure to it.

That said, many employers naturally will wish to be helpful. We therefore suggest that employers may wish to draw this issue to the attention of employees who may be affected and recommend that they take independent advice on it.

Affected employees who apply for fixed protection 2016 will need to opt out of further accrual in a registered pension scheme. That gives rise to a number of issues, including the following.

  • Are death-in-service benefits currently provided via the registered pension scheme? If so, members may be reluctant to lose this coverage. It is possible, and often desirable for a number of reasons (not just the LTA issue) to provide such benefits via a standalone insured scheme backed by an excepted group life policy.
  • What alternative remuneration package does the employer want to put in place as compensation for the loss of ongoing pension accrual?
  • How will individuals with fixed protection 2016 avoid losing it as a result of automatic enrolment? It is possible at the employer's option to exclude individuals with LTA protections from the automatic enrolment regime.
  • Whether there are any provisions in the scheme rules, typically relating to increases or revaluation, which could cause a loss of fixed protection 2016 even after a member opts out. This is an area on which legal advice may be needed.

The above is a high-level summary and is intended to aid understanding of the relevant issues and to enable individuals and employers to ask the right questions. It is not legal advice. If you would like to discuss any of the issues raised in this briefing, please contact Christopher Stiles.