30 MINS CPD COURSE PROTECTION OF PRE-A-DAY BENEFITS: PRIMARY PROTECTION
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1 30 MINS CPD COURSE PROTECTION OF PRE-A-DAY BENEFITS: PRIMARY PROTECTION
2 INTRODUCTION PART I PRIMARY PROTECTION THE INTRODUCTION OF THE LIFETIME ALLOWANCE ON 6TH APRIL 2006 LED TO A RANGE OF COMPLEX TRANSITIONAL PROTECTIONS, INCLUDING PRIMARY PROTECTION. THE MEASURES WERE NECESSARY TO PREVENT PENSION SAVERS BEING PENALISED FOR HAVING SAVED WITHIN THE ALLOWABLE LIMITS AT THE TIME, BUT THE RULES ARE COMPLEX. To understand: LEARNING OBJECTIVES The operation of primary protection. The protection of tax-free cash. The interaction with other forms of lifetime allowance protection. 1
3 PRIMARY PROTECTION PAGE 4 1. PRIMARY PROTECTION PAGE 6 SECTION 1. QUESTIONS PAGE 7 2. PRIMARY PROTECTION AND TAX-FREE CASH PAGE 9 SECTION 2. QUESTIONS PAGE 10 ANSWERS TO SECTION QUESTIONS 2
4 PROTECTION OF PRE-A-DAY BENEFITS Two main types of lifetime allowance protection were introduced along with the simplified pension regime. They were primary protection and enhanced protection. Protection of tax-free cash, either in conjunction with primary or enhanced protection or on a stand-alone basis for those members without formal protection, was also brought in. These measures were necessary to prevent unfair penalties being levelled against those who had built up high levels of benefits within the pre-pension simplification limits. In this guide we will focus on primary protection and the tax-free cash protection associated with it. 3
5 1. PRIMARY PROTECTION On 6th April 2006 the lifetime allowance was introduced at an initial level of 1.5 million with the expectation that it would be indexed each year: by fixed increments for the first five years and thereafter in line with inflation. A small percentage of pension savers had, under the pre A-day rules, already built up benefits in excess of that or were projected to exceed it by the time they reached retirement. Primary protection and enhanced protection enabled members to choose between being subject to the standard lifetime allowance or apply for a higher lifetime allowance. Up to three years were allowed to apply for either form of protection, enabling applications to be made up to and including 5th April Primary protection could be applied for by those with pension benefits in excess of 1.5 million on 5th April This meant that valuations of pension benefits had to be obtained and submitted to HM Revenue & Customs (HMRC). As the deadline for primary protection passed almost a decade ago, we will not cover the valuation process here, but details can be found in the archived Registered Pension Schemes Manual. A successful applicant was given a personalised lifetime allowance above the standard level, which was expressed as an additional factor. Initially, the additional factor enhanced the standard lifetime allowance for the member so that, whilst it was set at 1.5m for example, the member s personalised lifetime allowance was: 1.5m x 1.5m = 1.8m. And when the allowance rose to 1.6 million on 6th April 2007, the member s personal lifetime allowance tracked the increase: 1.6m x 1.6m = 1.92m. The standard allowance continued to rise until it reached its high point of 1.8 million in 2010/11 and 2011/12 but from 2012/13 it began its precipitous decline, eventually reaching 1 million in 2016/17. Because of this reversal of policy the allowance was planned to be indexed in line with inflation after reaching 1.8 million the link between the additional factor and standard lifetime allowance was severed. Thereafter, the additional factor is applied to 1.8 million until (or perhaps if) the standard lifetime allowance rises above this level. Continuing the example of Carl, the lifetime allowance (held at 1.8 million) results in a personalised lifetime allowance of: 1.8m x 1.8 million = 2.16 million This applies from 2010/11 onwards unless the standard lifetime allowance exceeds 1.8 million, which is unlikely in the foreseeable future. Following a successful application for primary protection, Carl whose total benefits on 5th April 2006 equalled 1.8 million has an additional factor of: 1.8m 1.5m = 300, ,000 = m 4
6 REVALUATION OF PREVIOUS CRYSTALLISATIONS As benefits are not always taken at the same time or even in the same tax year, an earlier crystallisation may have been assessed against a higher or lower lifetime allowance. The basic principle is that earlier crystallisations are revalued in line with any change to the lifetime allowance. However, where a member has primary protection the revaluation is not as you would expect. Even though the member has a personalised lifetime allowance, this does not factor into the revaluation of benefits. Rather, the standard lifetime allowance in force at the time and in the current tax year are used, ignoring the 1.8 million figure that the member s personalised lifetime allowance is based on. This combination of factors can result in some unusual outcomes. Where the previous crystallisation took place before 6th April 2014, 1.5 million is used instead of the current standard lifetime allowance unless the standard allowance has risen above this. Carl (see above) crystallised 525,000 in 2009/10. He would like to know how much lifetime allowance remains available in 2018/19. The standard lifetime was 1.75 million in 2009/10, which with the additional factor of 0.2 meant a personalised lifetime allowance of 2.1 million. His earlier crystallisation would have been expected, therefore, to have used up 25% of the lifetime allowance, but this is not the case. Instead, the crystallisation amount is revalued in accordance with the standard lifetime allowance, but replacing the current allowance with 1.5 million: 525,000 x 1.5 million = 450, million This leaves 1.71 million of the lifetime allowance remaining: 2.16 million 450,000 = 1.71 million PENSION DEBIT RESULTING FROM DIVORCE Primary protection cannot be given up but, if pension benefits are reduced because of a pension debit, it can be lost. A pension debit is one side of the transaction covered by a pension sharing order; the other being a pension credit. Where divorce proceedings decide that a sharing order is the preferred route to deal with pension benefits, one spouse s benefits are reduced (a pension debit) with a cash equivalent being transferred into the other spouse s pension (a pension credit). The former reduces the additional factor under primary protection or, in some case, revokes it entirely. Archie had pension benefits worth 2.1 million on 5th April 2006 and applied for primary protection. His additional factor was 0.4. In 2009, he divorced and, as a result of a pension sharing order, his benefits were reduced by 750,000. Before the pension debit he had a personal lifetime allowance of 2.52 million. Due to the pension debit his primary protection was revoked because his deemed value of benefits on 5th April 2006 was less than 1.5 million: 2.1 million 750,000 = 1.35 million INTERACTION WITH OTHER FORMS OF PROTECTION Primary protection could have been applied for along with enhanced protection. As enhanced protection provides a greater level of protection but prohibits contributions and benefit accrual, it takes priority. Only if enhanced protection is lost or revoked does the dormant primary protection become active. Doubling up on protection of pre A-day benefits enabled a member to fall back on a higher lifetime allowance should enhanced protection need to be revoked; for example, to accept a large employer contribution, to receive a pension credit following divorce or to make up for poor investment performance. With the standard lifetime allowance dropping to 1 million almost half of the 1.8 million primary protection lifetime allowance this may well have turned out to be a wise move. Someone who holds primary protection could not apply for any of the recent fixed protections or individual protections. There would be no benefit in doing so, as their personal lifetime allowance would always be lower. 5
7 Section 1. Questions 1A. A primary protection holder had total benefits of million on 5th April What is their lifetime allowance in 2018/19? i 2,250,000 ii 1,800,000 iii 1,288,000 iv 2,025,000. 1B. A primary protection holder crystallised 750,000 in March Assuming an additional factor of 1.0, how much lifetime allowance do they have remaining in 2018/2019? i 1,800,000 ii 2,850,000 iii 1,030,000 iv 1,975,000. 6
8 2. PRIMARY PROTECTION AND TAX-FREE CASH The maximum amount of tax free cash that can be paid to a primary protection holder depends on the amount that was available at A-day. If the available tax-free cash on 5th April 2006 was no more than 375,000 and no more than 25% of the fund, there are no special tax-free cash provisions, with the exception of the recently introduced 1.5 million lifetime allowance (rather than the current standard allowance) for primary and enhanced protection members entitled to the standard amount of tax-free cash. This aside, the fundamental rules apply, restricting entitlement to 25% of the fund or, if lower, 25% of the remaining 1.5 million lifetime allowance. If the A-day tax-free cash entitlement under a particular scheme was less or equal to 375,000 and greater than 25% of the fund, then automatic protection of tax-free cash may be available. This is known as scheme specific lump sum protection and is covered in a separate guide. Tax-free cash protection under the primary protection regime was available where an individual s tax free cash entitlement at A-day was greater than 375,000. HM Revenue & Customs issued a certificate following a successful application for primary protection, showing the amount of the lump sum. This amount has been re-valued in line with the increases to the lifetime allowance, which is held at the 2011/2012 level of 1.8 million, thus ignoring any subsequent reductions. The effect of this rule is that the A-day tax-free cash amount is simply up-rated by 20%. Archie s A-day tax-free cash entitlement was 500,000. Mo, a primary protection holder, had A-day tax-free cash of 350,000. This was less than the 375,000 required for lump sum protection. For this purpose, the notional lifetime allowance of 1.5 million applies from 6th April 2014 rather than the standard allowance. In 2018/19, Mo s maximum tax-free cash is the lower of: 25% of his benefits, and 1.5 million x 25% = 375,000 A fundamental principle of tax-free cash is that the maximum amount is based on the remaining lifetime allowance, rather than how much cash has already been received. This means that the full 375,000 mentioned in the above example might not be available. For example, if a pension is received without receiving a 25% lump sum perhaps because of a guaranteed annuity rate the lifetime allowance is reduced without the lump sum from that portion of the allowance being realised. The forgone tax-free cash cannot be made up at a later crystallisation event. These rules apply to standard tax-free cash, whether primary protection applies or not. A lump sum received once the lifetime allowance has been exhausted will be a lifetime allowance excess lump sum and will be subject to a 55% tax charge. His additional factor (see example above) was 0.4 resulting in a personalised lifetime allowance in 2018/19 of: 1.8 million x 1.8 million = 2.52 million As his tax-free cash at A-day was greater than 375,000, it is also protected: 500,000 x 1.8 million = 600, million 7
9 STAND-ALONE LUMP SUMS The stand-alone lump sum rules allow a primary protection holder to take all of their lump sum from one of their pension schemes rather than a proportion from each. This allows the maximum amount of tax-free cash to be taken where other factors might be restrictive. SUMMARY The decision to opt for Primary Protection was never a difficult one: if benefits exceeded the lifetime allowance, it should had been applied for. Once in place, it could not be revoked and now thanks to the changing legislation over the last decade it is more advantageous compared to the standard lifetime allowance than was originally intended. The final example shows this for someone with total benefits worth twice the standard lifetime allowance at A-day, but now worth around four times the allowance. Marilyn has a primary protection additional factor of 1.0 and total benefits held in one scheme of 4 million. Her tax-free cash entitlement on 5th April 2006 was 1 million. She crystallises all of her benefits taking her maximum tax-free cash of 1,200,000 ( 1,000,000 x 1.8m / 1.5m) and designates the rest into drawdown. Her lifetime allowance in 2018/19 is 3.6m ( 1.8 million x 1.8 million) and so a lifetime allowance charge will arise. Her lifetime allowance excess is 400,000. The lifetime allowance charge will be at the rate of 25% because the tax-free cash is deemed to have crystallised first and so the lifetime allowance excess is made up entirely of funds that were designated to drawdown. The tax charge is 100,000 and this amount reduces the fund available for drawdown to 2.7 million. In summary: Lifetime allowance is increased by 20% (increase in lifetime allowance since A-day) and 100% (lifetime allowance enhancement factor): 1.5m x 120% x 200% = 3.6m Tax free cash is increased by 20% in line with increase in the lifetime allowance to 1.8 million. 8
10 Section 2. Questions 2A. How much tax-free cash is available to someone who had 600,000 tax-free cash at A-day and successfully applied for primary protection, including protection of lump sum rights? i 720,000 ii 450,000 iii 375,000 iv Not enough information. 2B. In the above example, if A-day tax-free cash was 350,000, what would be the maximum tax-free cash in 2018/19 from a total uncrystallised fund of 1.7 million? i 425,000 ii 450,000 iii 250,000 iv 375,000. 9
11 ANSWERS TO SECTION QUESTIONS Section 1. 1A i 2,250,000 1B ii 2,850,000 Section 2. 2A i 720,000 2B iv 375,000 10
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