The new pensions regime was launched on 6 April 2006 and those individuals who had funds that exceeded or were likely to exceed the lifetime allowance were given the option of two forms of protection known as Primary Protection and Enhanced Protection.

The deadline for informing HM Revenue and Customs that you intend to opt for one of these protections is 5 April 2009.

Lifetime Allowance

The main feature of the new regime is a single lifetime allowance for everyone. This is the amount of pension savings that can be made in a lifetime without a tax penalty. For defined benefit schemes, it equates to the capital value of the accrued rights. In most cases, this deemed capital value is twenty times the accrued pension entitlement.

The allowance started at £1.5 million for the year from 6 April 2006 (A Day).

Planned increases follow each year as follows:

2007/08 - £1.60 million
2008/09 - £1.65 million
2009/10 - £1.75 million
2010/11 - £1.80 million

Any benefits in excess of the lifetime allowance would be subject to a lifetime allowance tax charge at 55%.

Primary Protection

Primary protection allows an individual to protect pre A-Day pension rights under the old rules, whilst also allowing them to continue to make pension provision under the new rules. This protection is only available to members who had pension rights in excess of the lifetime allowance at A-Day of £1,500,000. It is possible to also apply for enhanced protection, but if a member does so, the enhanced protection rules override the primary protection rules.

Registering for primary protection will give the member a higher personal lifetime allowance (PLA) than the standard lifetime allowance (SLA). This obviously gives some protection from possible tax charges on later pension events e.g. taking benefits.

The PLA is set by applying a lifetime allowance enhancement factor to the SLA.

Example

Joan had pension rights at A-Day worth £2,000,000. The SLA at that time was £1,500,000. The factor is calculated by dividing the value of the benefits, less £1,500,000 by £1,500,000 and rounding to two decimal places:

£2m - £1.5m divided by £1.5m = 0.34.

Joan therefore benefits from a PLA of 1.34 times the SLA. In 2008/09 this gives a PLA of £2,144,000 rather than the SLA of £1,600,000.

Should registration for Primary Protection be made?

The starting point in considering this question is to ascertain the value of the pension rights at 6 April 2006. Only rights under approved UK pension schemes can be protected, so only those rights need to be valued and there are differing methods of valuation depending on whether the rights have been crystallised or not (i.e. in payment or not). Additionally, there are differing rules for money purchase and defined benefit rights.

Primary protection can only be registered if the pension value at A-Day is in excess of the SLA, so a valuation will determine whether registration is appropriate or not. Whether or not registration is effected is a personal decision and should only be taken after independent professional advice has been sought from a pensions specialist.

If registration is sought and granted, H M Revenue & Customs will issue a certificate confirming the details of the protection and, once registered, the protection cannot be rescinded.

The key point of primary protection is that greater benefits can be taken from the pension fund, utilising the PLA of the member rather than the SLA before a tax charge is applied.

Enhanced Protection

Again, the enhanced protection rules allow individuals to protect pension rights built up before 6 April 2006 under the old pension rules. These rules fully protect an individual from having any annual allowance tax charge, lifetime allowance tax charge or lifetime allowance tax charge arising in respect of their pension rights. However, it is only available to individuals who have opted out of membership  of any scheme and who have not, and will not, participate in any pension scheme after 5 April 2006 except in extremely limited circumstances. This protection, in contrast to the primary protection, is available for individuals who have already accrued funds over the SLA or indeed to those with lower valuations who perhaps are expecting substantial growth in value. Therefore, registering under enhanced protection can offer very valuable tax breaks for some individuals.

What does it mean to future pension provision?

Enhanced protection can be applied to any fund regardless of the size of the fund at 5 April 2006. However, it is likely to appeal to those who feel they already have sufficient pension savings and particularly those who have pension savings worth more than the standard lifetime allowance or those that expect them to be worth more than this by the time they start to draw on them.

As mentioned, under primary protection it is possible to elect for both primary and enhanced protection for those individuals with pension rights valued at more than £1.5 million at 5 April 2006. The enhanced protection rules take priority, but if for some reason the enhanced protection is lost, there is the safety net of primary protection to fall back on. 

Registering for Protection

There is a three-year window from A-Day (5 April 2009) to register with H M Revenue & Customs for either primary or enhanced protection, or indeed both. Individuals must register by using H M Revenue & Customs’ registration form and once registered, H M Revenue & Customs will issue a certificate to the individual. The member is responsible for providing the scheme administrator with a copy of the certificate and indeed where benefits are vested in tranches, he must keep a record of the percentage of his PLA which has been used. It is also his responsibility to inform the scheme administrator of the remaining percentage of PLA available on any subsequent crystallisation event. 

If an individual makes a contribution outside of the limited circumstances allowed to an ‘enhanced protection fund’, they must advise H M Revenue & Customs within 90 days. Failure to notify can mean a fine of up to £3,000.

Summary

For those with large pension funds at 5 April 2006, it is still possible to register for primary and/or enhanced protection, although enhanced protection will not be possible if contributions other than in very limited circumstances have continued to be paid to the fund.

Action

The two protections offer very valuable tax shelters for larger funds and those who have not reviewed whether protection is appropriate should do so ahead of the registration deadline of 5 April 2009 to avoid a potential tax charge on a crystallisation event of 55%. Early action should be taken as it may take some time to obtain pension valuation information and to complete the far from simple forms.

Independent financial advice should of course be sort from a pension specialist to ensure that any action taken is appropriate to the client’s circumstances.  

Menzies Wealth Management adviser, Eric Norman-Walker, can be contacted on +44 (0)208 972 8945 or at enormanwalker@menzieswm.co.uk