When benefits are first drawn from a registered pension scheme, which is known as a benefit crystallisation event, the benefits taken are valued and tested against the lifetime allowance (LTA), currently set at £1.5 million. The lifetime allowance is the total overall value of pension benefits an individual may build up tax free in a registered pension scheme.
Accruing benefits above the value of the lifetime allowance is permitted. However, once an individual has used up his or her LTA, any further benefits will be subject to the LTA charge of 55% on lump sums and 25% on pension income, which will also be subject to income tax. In practice, many employers and employees take steps to avoid accrual in a registered pension scheme beyond the value of the LTA.
From 6 April 2014, the LTA will reduce to £1.25 million, extending its scope to more higher-paid or longer-serving individuals who have yet to retire. Employers may respond by remunerating affected employees by different means: accrual in an unregistered pension arrangement, a top-up scheme or simply extra cash.
Two new forms of protection will be available for those that have already built up large funds but did not take advantage of earlier forms of primary, enhanced or fixed protection 2012.
Fixed protection 2014 allows individuals to retain an LTA of £1.5 million, provided they give notice to HM Revenue and Customs before 6 April 2014 and cease all benefit accrual in registered schemes by that date. Fixed protection can easily be lost, for example if the individual is auto-enrolled but does not opt out, or if the employee retains certain forms of life assurance benefits from a registered pension scheme.
Those with pension savings worth more than £1.25 million on 6 April 2014 may also apply for individual protection, giving a personalised LTA of the value of their pension to a maximum of £1.5 million. Further benefit accrual will be allowed, but will be subject to the LTA charge, as will increases from investment returns or revaluation in defined benefit pension schemes.
Hogan Lovells is advising high earners choosing fixed protection 2014 or who have fixed protection 2012 to consider taking individual protection as well. Although often less valuable, individual protection will not be lost if the member inadvertently accrues further benefits. Alternatively, for some, transferring benefits to a qualifying recognised overseas pension scheme (Qrops) may be beneficial, but specialist financial advice should be taken.
Jill Clucas is of counsel at Hogan Lovells International