The trm Report - Issue 18, May 2005

Comment
Finance Act 2004: “Simplification” – Enhanced Protection
Mark Streatfield

The Finance Act 2004 sweeps away, with effect from 6 April 2006, the current tax rules governing pension provision and maximum benefits and replaces them with an overall limit on the total value of retirement benefits that will benefit from tax concessions, over a working lifetime. This is known as the Lifetime Allowance and will be £1.5m initially.

Some individuals will have already earned benefits valued in excess of £1.5m before 6 April and still more can expect to do so before they retire. There are transitional arrangements for these people, to enable them to shelter these benefits from the new tax charges that would otherwise apply to all benefit in excess of the Lifetime Allowance. The Inland Revenue initially proposed what is now known as Primary Protection, but in addition the Finance Act included an alternative method of protection, known as Enhanced Protection. This article deals only with Enhanced Protection.

Until the latest regulations were published, we thought the transitional arrangements were fairly straight forward. However this is not now the case for defined benefit schemes as can be seen below.

Individuals with pension rights at 5 April 2006 can protect these rights from the Lifetime Allowance charge when these rights come into payment (crystallise) after 5 April 2006. Unlike Primary Protection individuals can claim enhanced protection regardless of whether their total benefits earned to 5 April 2006 are valued at more or less than the Lifetime Allowance.

Enhanced Protection ensures an individual has no liability to the Lifetime Allowance charge on any benefit crystallisation event. In essence, Enhanced Protection allows benefits accrued to
5 April 2006, increased as described below until retirement, to be paid if no further benefit accrual takes place after 5 April 2006.

Individuals who claim Enhanced Protection can give up this protection at any time before reaching the age of 75 by taking certain actions, such as deciding to join or rejoin a pension arrangement to earn further benefits.

Enhanced protection will be lost in the following circumstances:

• P where “relevant benefit accrual” occurs under a registered pension scheme, after 5 April 2006
  
• where a transfer is made from any arrangement into a registered pension scheme and that transfer is not a “permitted transfer”
  
• where a new arrangement relating to the individual is made under a registered pension scheme otherwise than to receive a “permitted transfer”.

A scheme member who looses entitlement to Enhanced Protection must report this to the Inland Revenue within 90 days to avoid the possibility of a fine of £3000.

Whether “relevant benefit accrual” occurs depends on the type of arrangement under which the individual’s benefits are being provided.

For defined contribution arrangements “relevant benefit accrual” occurs if relevant contributions are made after 5 April 2006. A relevant contribution for the purposes of Enhanced Protection would not include contributions that can only be applied to provide benefits after the individual’s death or National Insurance Rebates as a result of contracting out of the State Second Pension (Protected Rights).
In money purchase arrangements investment growth from 5 April 2006 will be protected from the Lifetime Allowance charge.

For defined benefit arrangements “relevant benefit accrual” occurs if the total of the aggregate value of the benefit crystallisation events under the arrangement exceeds the “appropriate limit”.

The “appropriate limit” is the greater of:

a) the benefits recalculated on the basis of the member’s age and pensionable earnings when they come into payment. For this purpose, pensionable earnings are restricted to:

• for those subject to the Earnings Cap at 5 April 2006, earnings in any 12-month period in the last 3 years, subject to a maximum of 7.5% of the standard Lifetime Allowance
  
• for those not subject to the Earnings Cap at 5 April 2006, if the best 12 months figure would exceed 7.5% of the standard Lifetime Allowance, the average of the last 3 years’ earnings can be used if greater; or

b) the benefits at 5 April 2006 increased in line with the greater of:

• 5% per annum
  
• RPI; or
  
• the percentage to be specified in Regulations.

It will be important for any individual whose benefits at 5 April 2006 will be substantial relative to the Lifetime Allowance, to seek advice on which method of transitional protection is most suitable to their circumstances. This is because, whilst registering for either form of protection can be done up to 5 April 2009, Enhanced Protection is only available if no further benefits accrue (as described above) from 6 April 2006. Advice, decisions and action therefore need to be taken before April 2006.

Registration for Enhanced and/or Primary Protection is the responsibility of the individual, not the scheme, although it would make sense for schemes to be informed.

Is planning for the future getting any simpler?

Mark Streatfield
Divisional Director
SBJ Benefit Consultants Ltd
020 7816 2419

mark.streatfield@sbjbc.co.uk
www.sbjbc.co.uk