30 MINS CPD COURSE PROTECTION OF PRE-A-DAY BENEFITS: ENHANCED PROTECTION

Transcription

1 30 MINS CPD COURSE PROTECTION OF PRE-A-DAY BENEFITS: ENHANCED PROTECTION

2 PART II ENHANCED PROTECTION THE INTRODUCTION OF THE LIFETIME ALLOWANCE ON 6TH APRIL 2006 LED TO A RANGE OF COMPLEX TRANSITIONAL PROTECTIONS, INCLUDING ENHANCED PROTECTION. THE MEASURES WERE NECESSARY TO PREVENT PENSION SAVERS BEING PENALISED FOR HAVING SAVED WITHIN THE ALLOWABLE LIMITS AT THE TIME. LEARNING OBJECTIVES To understand: The operation of enhanced protection. Protection of tax-free cash. The interaction with other forms of lifetime allowance protection. 1

3 PAGE 3 1. ENHANCED PROTECTION PAGE 6 SECTION QUESTIONS PAGE 7 2. ENHANCED PROTECTION AND TAX FREE CASH PAGE 9 SECTION 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 ENHANCED PROTECTION AND THE TAX-FREE CASH PROTECTION ASSOCIATED WITH IT. 1. ENHANCED PROTECTION Enhanced protection provides a complete exemption from the lifetime allowance charge for all eligible benefits, which are those that derive from benefits that were within HM Revenue & Customs limits before A-day. Excess benefits had to be surrendered to be able to apply. This aside, anyone could have applied; there was no minimum value of benefits. No further contributions or accruals are/were allowed after 6th April Consequently, an application was only worthwhile if pre-a-day benefits were above or projected to grow beyond the lifetime allowance at retirement. The application deadline was 5th April 2009 and protection applied from A-day. Taking benefits HM Revenue & Customs issued a certificate to successful applicants, which they are required to give to any schemes that they receive benefits from. The certificate ensures that, if the member has not breached the conditions for enhanced protection, the scheme does not deduct a lifetime allowance charge. However, there is still a benefit crystallisation event (BCE) and the scheme administrator has to collect certain details and disclose information to the member. Losing enhanced protection If enhanced protection has been revoked, there is a BCE using the standard lifetime allowance when benefits are taken and, if the lifetime allowance is exceeded, a lifetime charge will arise in the usual way. Earlier BCEs are not revisited. There are two main ways that enhanced protection can be lost: it can be given up voluntarily or it can be lost because of breaching certain conditions. The former is self-explanatory; the latter can be because of a non-permitted transfer, setting up a new arrangement or because of relevant benefit accrual. Non-permitted transfers Any transfer other than a permitted transfer causes loss of enhanced protection. Permitted transfers are: Transfers from any type of registered pension scheme (including a recognised overseas pension scheme) to a money purchase scheme, including partial transfers. If the transfer is from a defined benefit (or cash balance) scheme the value transferred must be actuarially equivalent to the rights held in the transferring scheme. Transfer from a defined benefit (or cash balance) scheme to another defined benefit (or cash balance) scheme in certain permitted circumstances, which are explained in the Pensions Tax Manual. Transfer of funds to set up a scheme pension using already crystallised funds following a scheme wind up. All other transfers are non-permitted transfers and result in enhanced protection being revoked. 3

5 New arrangements New arrangements cannot be established, with three exceptions. The most common is a new arrangement set up to accept a permitted transfer, such as a defined benefit transfer to a personal pension. Two other exceptions apply, which are related to specific compliance exercises that an employer might carry out. These are explained in the Pensions Tax Manual. A new arrangement created in other circumstances causes enhanced protection to be lost. For example, receipt of a pension credit in to a new arrangement following a pension sharing order is not allowed, because a transfer of a pension credit is a non-permitted transfer. If, alternatively, the pension credit is transferred to an existing arrangement this does not result in protection being lost because no new arrangement has been set up. Another situation where a new arrangement may have to be set up is during the restructure of benefits to access a small lump sum or small pot. The rules, which do not trigger the 4,000 money purchase annual allowance, enable up to three arrangements to be fully crystallised during an individual s lifetime but each arrangement cannot pay out more than 10,000. A personal pension arrangement, for example, worth 29,700 is not accessible under the small pots rules. But if it could be split into three arrangements worth 9,900 each, all three would be accessible provided the member has not previously used this option. The creation of two new arrangements results in the loss of enhanced protection, so the member should consider an alternative approach such as making two partial transfers out to another scheme. Automatic enrolment of a worker by their employer causes loss of enhanced protection, because a new arrangement is established for them. But those who opt out fully (as opposed to just leave the scheme) are treated as having never been a member of the scheme, and do not revoke protection. Enhanced protection members who are automatically enrolled should ensure they know when the opt-out period begins and ends and ensure they opt out properly. It is not possible to opt out of the automatic enrolment process, only the scheme once automatic enrolment has achieved active membership. However, by concession employers can choose not to enrol certain workers if they have good evidence (sight of the certificate) that they have lifetime allowance protection. 4

6 Relevant benefit accrual Enhanced protection is lost if certain contributions are made or benefits are accrued. Within defined contribution schemes, if a contribution is made by or on behalf of the member, protection is lost other than in very limited circumstances. In defined benefit schemes, protection is lost if benefits increase by more than a certain amount. In either case, there is relevant benefit accrual and the standard lifetime allowance applies. Within a defined benefit environment, benefits can increase to retain their value in real terms, keeping pace with inflation and the individual s earnings. The limit is called the appropriate limit, but the rules are complex and beyond the scope of this course. Refer to Pensions Tax Manual for more information. The test is an output test, which means only when there is a BCE (i.e. benefits are taken or transferred overseas) or permitted transfer is there an assessment to determine if benefits have increased by more than the permitted amount. If there is, protection is lost but it does mean that some members will not be sure whether they have stayed within the limit until they come to take benefits or transfer. This contrasts with fixed protection, which uses an input test and revokes protection if more than the permitted amount has been accrued within a defined benefit scheme. Divorce Pension credits and divorce A defined contribution member that has had a pension debit deducted from their fund cannot rebuild benefits because no contributions are allowed. A defined benefit member, however, can because the benefit accrual test looks at whether the benefits when received have increased since 2006, allowing the deficit to be restored. A defined contribution member that had a pension credit added to their funds will, provided the credit was paid into an existing arrangement (as explained above) retain protection. But a defined benefit member is likely to lose protection as a significant pension credit will increase their benefits beyond the limits allowed. Notifying HMRC If enhanced protection is lost, the scheme member must inform HM Revenue & Customs within 90 days or potentially face a 3,000 penalty. IF ENHANCEMENT PROTECTION IS LOST INFORM HMRC WITHIN 90 DAYS Certain contributions towards life assurance policies can continue, however they must have been set up before 6th April

7 Section 1 Test your knowledge a) When is enhanced protection effective from? i) 6th April 2009 ii) 6th April 2011 iii) When HMRC issued the certificate. iv) 6th April 2006 b) A pension scheme member had 4.5 million worth of benefits at A-day. They successfully applied for enhanced protection. What is their lifetime allowance in 2018/19? i) 3.09 million ii) 5.4 million iii) Not applicable. iv) 1.5 million c) From a personal pension worth 18,000, a partial transfer out of 9,000 is made to a separate money purchase scheme. Does this cause enhanced protection to be revoked? i) No ii) Yes iii) No, provided the resulting benefits are paid out as small pots 6

8 2. ENHANCED PROTECTION AND TAX FREE CASH The amount of tax-free cash that may be taken depends on how much was available at A-day. If the available tax-free cash at that point was no more than 375,000 or 25% of the fund, there are no special provisions. The normal lump sum rules apply: entitlement is restricted to 25% of the fund or, if lower, 25% of the lifetime allowance, which for this purpose is 1.5 million (see below). If the A-day tax-free cash amount was no more than 375,000 but greater than 25% of the fund then scheme level protection of tax-free cash may be available. See the separate CPD guide on this subject. Where an individual s tax-free cash entitlement at A-day exceeded 375,000, protection of tax-free cash in conjunction with enhanced protection is available. The amount of tax-free cash available is expressed as a percentage and is shown on the certificate that was issued by HMRC. The member s tax-free cash entitlement remains as a percentage of the fund, irrespective of by how much the benefits grow. Example Taking tax-free cash under Enhanced Protection Anita has 2 pensions and her total benefits at A-day were 4.5 million. Her lump sum rights at that date were 900,000, which was 20% of the total. She applied for enhanced protection, including protection of lump sum rights. As her lump sum entitlement was 20% of her total benefits, this is the maximum lump sum she can take from each scheme. On 1st November 2016 she designates one of her pensions into drawdown. She receives 250,000 as a lump sum and 1 million goes into drawdown. The lump sum is 20% of the total amount crystallised, which is the maximum amount allowed from each scheme. If, in the above example, Anita does not take the full 20% lump sum from either plan, she cannot make up the unused amount from another plan. Therefore, if scheme rules further restrict the available tax-free cash, then the maximum percentage shown on the certificate will not be accessible. Tax free cash restricted to 25% of the lifetime allowance As mentioned above, where the A-day tax-free cash entitlement was less than 375,000 and no more 25% of the fund, neither enhanced nor primary protection offer any tax free cash protection, but from 6th April 2014 there is some protection against the reduction in the lifetime allowance to 1 million. This comes in the form of a notional 1.5 million lifetime allowance rather than the standard lifetime allowance for tax-free cash purposes. This was first mentioned in HM Revenue & Custom s Pension Schemes Newsletter 57: uk/ / pensionschemes/pts-newsletters.htm Example Notional lifetime allowance for non-protected members Mitch had benefits of 1.6 million at A-day and applied for enhanced protection. His then tax-free cash entitlement was 240,000, which meant that enhanced protection would not cover his lump sum entitlement. When he crystallises benefits in 2018/2019, his fund is worth 2 million. The maximum tax-free cash he may take is the lower of 25% of the notional 1.5 million lifetime allowance and 25% of the fund; therefore 375,000. In May 2018, she takes benefits from another pension scheme. The total value is 1 million, 200,000 of which can be taken as a lump sum. 7

9 Summary The decision to opt for Enhanced Protection was, in some cases, clear cut; in others, less so. However, those who weren t quite sure whether their benefits would increase by more than the lifetime allowance are, following its sharp reduction since 2012, now surely in a better position with enhanced protection than they would otherwise have been. A more significant point is whether they have done everything required to retain protection since Although it has been technically possible to remain in active membership of a defined benefit scheme without having relevant benefit accrual, it is highly unlikely. So, along with those DC members who have paid contributions or had contributions paid on their behalf they have most likely lost their protection. As have any individuals who have been automatically enrolled and not opted out within the opt-out period. Deferred defined benefit members and fully paid up members of DC schemes (since 2006) should have retained protection, but their activity since 2006 should be checked before a BCE or permitted transfer. 8

10 Section 2 Test your knowledge a) At what level of benefits does enhanced protection cover tax-free cash? i) More than 375,000 on 5th April 2006 ii) More than 25% of benefits on 5th April 2006 iii) More than 25% of benefits and 375,000 on 5th April 2006 iv) More than 25% of benefits at any time. b) A pension scheme member had 2 million worth of benefits at A-day, 350,000 of which was tax-free cash. How much tax free cash can they take from their benefits, worth 2.5 million in 2018/19? i) 437,500 ii) 625,000 iii) 257,500 iv) 375,000 c) A member with tax-free cash protection under enhanced protection had total benefits worth 1.8 million at A-day, 540,000 of which was tax-free cash. How much cash can they receive now their benefits are worth 2 million? i) 600,000 ii) 500,000 iii) 375,000 iv) 540,000 9

11 ANSWERS TO SECTION QUESTIONS 1a) iv 1b) iii 1c) i 2a) i 2b) iv 2c) i 10

12 Scottish Widows Limited. Registered in England and Wales No Registered office in the United Kingdom at 25 Gresham Street, London EC2V 7HN. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. Financial Services Register number (PA) 08/18