Pensions: Lifetime Allowance Protections

Introduction

On 15 March 2023, the Chancellor announced that the lifetime allowance (LTA) for pensions will be abolished. The LTA is the total amount that an individual can accumulate in UK registered pension schemes and relevant overseas pension schemes without incurring certain tax charges. The LTA charge was abolished from 6 April 2023, but the LTA itself remains in force for the 2023/24 tax year. The level of the LTA remains relevant for determining the size of certain lump sums and how lump sums may be taxed. In particular, the 25% tax-free lump sum (pension commencement lump sum) is normally capped at 25% of the available LTA if it arises when the LTA is in force. The standard LTA is currently £1,073,100, and the pension commencement lump sum would normally therefore be capped at 25% of this figure, but higher LTAs may apply if certain protections are claimed. If a protection results in an LTA of £1,800,000, the pension commencement lump sum would therefore normally be capped at £450,000 rather than £268,275.

The LTA will be replaced by two new allowances from 6 April 2024, the ‘lump sum allowance’ (LSA) and ‘lump sum and death benefit allowance’ (LSDBA). The LSA caps the amount that can be taken tax-free in lifetime in the form of pension commencement lump sum or the tax-free element of an uncrystallised lump sum. The LSDBA caps the amount that can be taken tax-free in life and death combined. The standard LSA and LSDBA are £268,275 and £1,073,100, respectively. This is intended to broadly replicate the tax-free amounts that are typically available under the LTA regime. If the individual would be entitled to higher tax-free lump sums under the current regime due to an LTA protection, their LSA and LSDBA will be increased accordingly. LTA protections therefore remain relevant despite the abolition of the LTA. If any of the LTA is used before 6 April 2024, transitional rules apply to reduce the amount of LSA and LSDBA available.

If pension savings are over the LTA, there may be a tax charge when benefits are taken before the earlier of 6 April 2024 and the member’s 75^th birthday. Benefits that trigger an LTA test include lump sums, using funds to provide pension income (including drawdown designation) and death benefits. Prior to 6 April 2023, the excess over the LTA was taxed at 55% if it was taken as a lump sum or 25% otherwise. From 6 April 2023, lump sums that would previously have been taxed at 55% (e.g. LTA excess lump sum) are instead treated as pension income of the recipient and taxed at their marginal income tax rate. The 25% LTA tax charge no longer exists and has not been replaced. The individual’s 75^th birthday triggers an LTA test if they have uncrystallised funds or a drawdown fund, but there is no tax charge from 6 April 2023 as it would previously have been subject to the 25% rate.

The LTA was introduced on 6 April 2006. It was originally set at £1.5 million and was increased to £1.8 million before being subject to a series of reductions. Various forms of LTA protection were introduced to prevent unfair tax treatment of those who had saved with a previous set of rules in mind. Two forms, which can potentially still be claimed until 5 April 2025, relate to the last LTA reduction on 6 April 2016 from £1.25 million to £1 million. The first is called Fixed Protection 2016 and the second is called Individual Protection 2016. Similar protections were introduced on the previous reductions in the allowance. The deadlines for earlier forms of Fixed Protection and Individual Protection 2014 have now passed. Previous forms of transitional protection that have been claimed (Primary Protection, Enhanced Protection, Fixed Protection 2012, Fixed Protection 2014 and Individual Protection 2014, details of which are below) all continue to be effective.

This note provides a brief explanation of the newer protections, together with a reminder of existing protections that may already have been claimed, and explains what actions should be considered. 

Individual Protection

Individual Protection 2014 was available to individuals who had aggregate pension savings valued at more than £1.25 million as at 5 April 2014 and who did not have Primary Protection in place. It was possible to claim this protection alongside Enhanced Protection or any of the forms of Fixed Protection. The deadline for claiming this protection was 5 April 2017.

Individual Protection 2014 gives the individual a personal LTA equal to the greater of the standard LTA and the value of pension savings at 5 April 2014, subject to an overriding maximum of £1.5 million. From 6 April 2024 their LSDBA will be equal to the personal LTA and their LSA will be 25% of this figure. Unlike Enhanced Protection and Fixed Protection, there was no requirement to stop pension saving in order for Individual Protection 2014 to apply.

Individual Protection 2016 works in the same way as Individual Protection 2014, but with lower thresholds - i.e. it is available to individuals with pension savings valued at more than £1 million at 5 April 2016 and provides a personal LTA equal to the value of those savings at 5 April 2016, subject to an overriding maximum of £1.25 million. If the value protected is less than the standard LTA at the time benefits are crystallised (e.g. between £1 million and £1,073,100 in 2023/24), the standard LTA applies. Individual Protection 2016 must be claimed by 5 April 2025. Claims can be made online at http://deloi.tt/2aiS5uw. 

Although other forms of protection may produce a higher threshold of protection, Individual Protection can limit the downside of inadvertent loss of the other forms of protection. For example, if the individual’s pension was valued at £1.2 million on 5 April 2016 and they claimed Fixed Protection 2016 and Individual Protection 2016, these would protect up to £1.25 million and £1.2 million, respectively. Although Fixed Protection 2016 appears to be more generous, there are circumstances when it could be lost, which would normally result in the LTA falling to £1,073,100 (with a corresponding reduction in the 25% pension commencement lump sum). Claiming Individual Protection 2016 would provide a floor of £1.2 million.

Fixed Protection

Each reduction in the LTA has been accompanied by a form of Fixed Protection. These are Fixed Protection 2012, Fixed Protection 2014 and Fixed Protection 2016. 

Each form of Fixed Protection allows the claimant to retain the level of LTA that was available immediately before the reduction. There is no minimum fund value requirement for Fixed Protection. In order to benefit from this protection, the individual was not allowed to make any further pension savings on or after the date of the relevant LTA reduction (whether the savings consist of contributions to money purchase schemes, including employer contributions, or further accruals in a defined benefit scheme). If any further pension savings were made on or before 5 April 2023, or certain other protection cessation events occurred (e.g. joining a new pension arrangement), these protections were lost. From 6 April 2023, Fixed Protection can only be lost if it was claimed on or after 15 March 2023 (i.e. if the protection was claimed before that date, and was not lost on or before 5 April 2023, the individual can resume making pension contributions from 6 April 2023 without losing protection). The individual has an obligation to notify HMRC within 90 days of loss of protection and failure to do so may give rise to penalties.

For Fixed Protection 2012 and Fixed Protection 2014, there was a further requirement that the claim for protection had to be filed with HMRC before the reduction in the allowance took effect. Fixed Protection 2016 can be claimed until 5 April 2025, although pension savings must have ceased by 5 April 2016 (new claimants cannot resume contributions without losing protection). Like Individual Protection 2016, it must be claimed online at http://deloi.tt/2aiS5uw.

The three forms of Fixed Protection are summarised as follows:

Unlike Individual Protection, Fixed Protection can protect further growth in the fund up to the level of allowance secured, provided it is not lost before benefits are crystallised. Fixed Protection 2016 may therefore be of interest to individuals with pension savings worth less than £1,073,100 but who expect future investment growth to push the value over this limit. Fixed Protection is not available to individuals who hold Primary Protection or Enhanced Protection (see below) and only one form of Fixed Protection can be in force at a given time. Individuals who claimed an earlier form of Fixed Protection, but subsequently lost it, should therefore be eligible for Fixed Protection 2016, provided no pension savings have been made on or after 6 April 2016.

Those who claim Fixed Protection 2016 on or after 15 March 2023 who had pension savings in excess of £1,073,100 as at 5 April 2016 may wish to apply for Individual Protection 2016 in order to limit the downside in the event that Fixed Protection 2016 is lost, as explained above.

Primary and Enhanced Protection

When the current pension regime was introduced on 6 April 2006 (A Day) the LTA was set at £1.5 million. This gradually increased to £1.8 million by 6 April 2010. As many taxpayers already had pension savings before A Day that were likely to breach the LTA by the time they drew benefits, Primary Protection and Enhanced Protection were introduced. The deadline for electing for these protections was 5 April 2009. In theory these can still be claimed if there is a reasonable excuse for the delay, but in practice this is very rare.

Primary Protection was available to individuals with pension savings at A Day in excess of £1.5 million. It gives the individual an enhanced LTA based on the proportion by which those savings exceeded £1.5 million. If pension savings at A Day totalled £3 million, the individual would therefore benefit from double the standard LTA at the time that benefits are crystallised. For the purposes of this calculation, the standard LTA has been deemed to be £1.8 million since 6 April 2012. It is not possible to withdraw Primary Protection and it is not lost if further pension savings are made. Individuals who hold Primary Protection are not eligible for any of the forms of Fixed Protection or Individual Protection. They will be entitled to an LTA of at least £1.8 million, however, which should be more beneficial than the newer protections. The LSDBA of Primary Protection holders will be equal to their enhanced LTA. They may also have a higher LSA, but this will depend on whether they qualified for a higher protected lump sum rights under the LTA regime.

Enhanced Protection was available to anyone, irrespective of the value of their pension savings at A Day. Enhanced Protection provides an exemption from the LTA charge and can increase the amount of pension commencement lump sum available. In order to benefit from this protection, pension savings had to cease by 5 April 2006 (although some small accruals in defined benefit schemes within specified limits are allowed). If any further pension savings were made on or before 5 April 2023, or certain other protection cessation events occurred (e.g. joining a new pension arrangement), the protection was lost. From 6 April 2023, Enhanced Protection can only be lost if it was claimed on or after 15 March 2023 (i.e. if the protection was claimed before that date, and was not lost on or before 5 April 2023, the individual can resume making pension contributions from 6 April 2023 without losing protection). The individual has an obligation to notify HMRC within 90 days of loss of protection and failure to do so may give rise to penalties. Enhanced Protection can be given up voluntarily, but the circumstances under which this is beneficial are rare.

The effect of Enhanced Protection on the pension commencement lump sum depends on whether the value of lump sum rights on A Day exceeded £375,000. Where the value exceeded this limit, the pension commencement lump sum before 6 April 2023 was normally effectively 25% of the value of the fund, without regard to the LTA. From 6 April 2023 it will be capped at the amount that could have been taken as at 5 April 2023. If the value of lump sum rights at A Day was £375,000 or less, the pension commencement lump sum is capped at 25% of the available LTA. In the absence of other protections, the LTA is normally deemed to be £1.5 million for this purpose. The LSA for Enhanced Protection holders is based on the lump sum cap that applies in 2023/24. Their LSDBA will be based on the value of their uncrystallised pension rights as at 5 April 2024.

In some circumstances, additional standalone lump sum protections were also available from A Day. From 6 April 2023 these are capped at the amount that could have been taken as at 5 April 2023.

Death in service

Death in service benefits provided by employers are sometimes provided via a pension scheme. If such benefits become payable, they are tested against the LTA up to 5 April 2024 and against the LSDBA thereafter. They may also have an impact on Fixed Protection and Enhanced Protection if the cover started before 6 April 2023 (or where cover starts later but protection was claimed on or after 15 March 2023).

Where an individual is already a member of the pension scheme before electing for Fixed Protection or Enhanced Protection, and the benefit provided is a simple multiplier of salary, retaining the death in service benefits afterwards will not normally affect the protections. This is because it is a defined benefit arrangement and no benefit has accrued (i.e. there are no pension rights to measure in lifetime, so the value of the rights do not increase). 

Entering into a new death in service arrangement via a pension scheme after electing for Fixed Protection or Enhanced Protection can cause protection to be lost due to an additional condition whereby the individual is not allowed to become a member of a new pension arrangement otherwise than under ‘permitted circumstances’. ‘Permitted circumstances’ normally include a transfer of existing rights from one scheme to another, but it does not include a new scheme for the provision of death in service benefits. This would typically arise when an individual changes employment and the new employer’s death in service benefit is provided via a pension scheme. Joining such a scheme after taking out Fixed Protection or Enhanced Protection can therefore cause protection to be lost, even though no benefits have accrued. As Fixed Protection and Enhanced Protection can only be lost from 6 April 2023 if they were claimed on or after 15 March 2023, this should now be relatively rare.

Although the LTA charge no longer applies from 6 April 2023, death in service payments are subject to a tax charge if paid in 2023/24 to the extent that they exceed the available LTA. Similarly, payments in excess of the LSDBA from 6 April 2024 will be taxable. In either case the excess is treated as pension income of the recipient and taxed at their marginal income tax rate.

Further actions

Individuals who have Primary Protection do not need to take any action with regard to the newer protections, as they are neither necessary nor available.

Individuals who wish to claim the current protections will need to have Government Gateway login details for HMRC’s online services. If an account does not already exist, one will need to be created at http://deloi.tt/gateway.

Individuals with pension savings valued at over £1,073,100 as at 5 April 2016 who do not have other forms of protection (or who claimed Enhanced Protection or Fixed Protection 2016 on or after 15 March 2023) may now wish to consider applying for Individual Protection 2016. 

Individuals who already held Enhanced Protection or any form of Fixed Protection before 15 March 2023 may now resume pension saving without affecting those protections. If any of these protections are claimed on or after 15 March 2023, the individual must not make any further pension savings if they wish to retain the protection (in practice this is only likely to be relevant to Fixed Protection 2016). Where protection has been lost, whether deliberately or accidentally, the individual has a duty to notify HMRC of this within 90 days. Failure to do so may result in penalties. As noted above (see ‘Death in service’), becoming a member of a new pension arrangement can also cause protection to be lost, even if no benefits have accrued. Individuals who have breached these conditions since 6 April 2016 are ineligible for Fixed Protection 2016.

The decisions about making or ceasing to make pension savings will be financial ones. Additionally, in order to apply for Individual Protection, valuations of pension benefits will be required. Deloitte LLP does not offer regulated advice to individuals and so financial advice from an FCA regulated pensions adviser should therefore be sought where appropriate.