Page 1 of 8 News Alert 2011/08

November 2011

Fixed Protection 2012 - HMRC guidance issued

At a glance

HM Revenue & Customs (HMRC) has published Newsletter 50 setting out some much-awaited answers on the operation of Fixed Protection the transitional protection available to individuals concerned about the impact of the reduction in the Lifetime Allowance (LTA) from 1.8m to 1.5m on 6 April 2012. Even more so than usual with transitional arrangements the law is complex, in particular in relation to defined benefits, so HMRCs guidance is key. The Newsletter contains some surprises; and there are opportunities and pitfalls, as well inevitably as new unanswered questions.

Key Actions

Employers

Decide to what extent you want to help scheme members providing advice, offering alternatives or making rule changes to make the most of the limited opportunities.

Be aware of pitfalls some rule changes/scheme reconstructions now, or in the future, could lose members the possibility of Fixed Protection.

Trustees

Be aware that individuals may ask for information about their benefits which only the scheme can identify to help them decide whether Fixed Protection will help them.

If the employer wants to make rule changes, these may need speedy implementation and communication to members.

Remember that future changes to benefits could lose members their Fixed Protection.

Scheme administrators

As well as information provision now, plan for the future impact on administrative processes. This includes systems having to recognise that some members may have a different standard LTA.

The Detail

Fixed Protection is available in conjunction with the fall in the LTA from 1.8m to 1.5m from 6 April 2012; and allows an individual to retain a LTA of 1.8m subject to some conditions, including, very broadly that they make no further tax-relieved pension

http://www.hmrc.gov.uk/pensionschemes/newsletter50.pdf

Page 2 of 8 savings. Members may think that they have to leave defined benefit schemes to use Fixed Protection, but this is not necessarily the case the devil as always is in the detail.

Technically, whilst a member has Fixed Protection, when they draw benefits after 5 April 2012 they are treated for all purposes (including calculating any LTA charge and the scope for tax-free cash sum at retirement) as having a standard LTA of 1.8m rather than 1.5m.

Comment

Without such protection the LTA reduction from 1.8m to 1.5m might be said to be

a retrospective tax, on pensions savings made, but not drawn, before 6 April 2012.

Where a members total benefits ultimately have an HMRC value of more than

1.5m, having Fixed Protection will mean paying no or less LTA charge and more

benefits can be taken as a tax-free lump sum. The tax saving could be as much as

75,000 but could be much less.

The decision whether to take up Fixed Protection will be complex particularly for

those who can only do so by opting out of further pensions savings: they will need to

model their expectations of future investment growth on DC funds; and for defined

benefit leaver revaluation compared to on-going pensionable salary linking and

service accrual (if and while this is still on offer from the employer), early

retirement plans etc - and consider this against an LTA which may not increase for

some time if ever, and expectations for tax rates for the future.

For those planning on drawing benefits in the next couple of years the modelling for

the decision may be relatively straightforward but for those with a longer

timeframe, the decision can be very difficult due to the number of variables involved

and the way the protection works. Some individuals may choose to avoid all these

concerns by drawing all benefits before 6 April 2012.

Who can apply for Fixed Protection?

Anyone with uncrystallised pension rights at 5 April 2012 who does not have either Enhanced Protection or Primary Protection (the transitional protections introduced when the tax rules for pensions were changed in 2006) can apply regardless of whether existing benefits are valued at more than 1.5m. Those wishing to rely on Fixed Protection must complete form APSS227 (to be found with accompanying notes on www.hmrc.gov.uk/pensionschemes/protection.htm) and post it to HMRC, to be received by HMRC by 5 April 2012.

Comment

HMRC emphasises that this is a fixed deadline, and it is now only four months off.

Individuals have a limited time to take advice as to whether Fixed Protection is right

for them and take any specific actions needed by that date (for example, a member

who has Enhanced Protection can give this up before 6 April 2012 and apply for

Fixed Protection if it is expected to be more advantageous).

http://www.hmrc.gov.uk/pensionschemes/protection.htm

Page 3 of 8 Fixed Protection can be lost

In principle (if not quite in practice), Fixed Protection is intended to protect benefits built up before 6 April 2012 and not future benefits. So the protection comes with several conditions, which if broken, means Fixed Protection is lost thereafter. For subsequent benefit tests (for benefit entitlements crystallising from any scheme the member has) the individuals overall lifetime allowance falls back to a (reduced) standard LTA of 1.5m1.

Protection will be lost if, at any time after 5 April 2012, an individual:

has benefit accrual under an arrangement; or

transfers their benefits in a way that is not a permitted transfer; or

has an impermissible transfer into an arrangement; or

joins an arrangement otherwise than in permitted circumstances.

These conditions are similar to the conditions for losing Enhanced Protection with the important exception of the detail on benefit accrual (see below).

Individuals must tell HMRC within 90 days if Fixed Protection no longer applies. If HMRC discovers that an individual has not yet so reported, it can impose a fine of 300.

What is benefit accrual?

The definition of benefit accrual depends upon the type of arrangement the benefits are in.

For a Defined Contribution (DC) arrangement, benefit accrual arises (so will cause loss of Fixed Protection) as soon as there is a payment (or allocation) of any contribution2 for the member after 5 April 2012.

For a Defined Benefit (DB) arrangement, the test is more complicated see below.

Comment

Newsletter 50 highlights that joining any new arrangement (that is part of a

registered pension scheme) after 5 April 2012 outside very limited permitted

circumstances loses Fixed Protection including arrangements solely providing life

cover. Employee life cover arrangements are frequently restructured as part of a

redesign of benefits, for example when accrual in a DB scheme ceases: this should be

1 But note that an individual who has drawn 1.5m of benefit while their LTA was 1.8m before

losing protection would still be able to draw benefit of 250,000 after (when the LTA to use is

1.5m) without facing an LTA charge because of the calculation mechanics (the first uses up 83%

of LTA (1.5m/1.8m), the second uses up 17% (0.25m/1.5m)).

2 There are exceptions eg contributions deemed to represent contracting out rebates.

Page 4 of 8 borne in mind and planned for. We note that even on-going life cover might cause

loss of protection if it counts as being on a defined contribution or hybrid basis

trustees may wish to check their arrangements with their lawyers on this point.

Not mentioned in Newsletter 50 but in other HMRC guidance is the point that if, as

a result of the Governments imminent new requirements, an employee with Fixed

Protection is auto-enrolled (or re-enrolled as part of the three yearly requirements),

they will lose the protection unless they use the statutory opt-out opportunity within

one month so that the law treats them as if they had never joined (the same risk is of

course true for those with Enhanced Protection).

Note that when an individual presents a Fixed Protection certificate with a view to

this reducing an LTA charge that would otherwise be due, trustees may feel obliged

to instruct their administrators to check that what has happened in the scheme since

5 April 2012 has not lost the member the Protection: LTA charge is a joint and

several liability on the trustees and member, with exoneration for the trustees only

if they reasonably believed that there was no liability to the charge.

The benefit accrual test for DB arrangements

Benefit accrual occurs in a DB arrangement (so Fixed Protection is lost) if the HMRC value of uncrystallised benefits (pension and, if as of right rather than by commutation, lump sum) increases in a tax year by more than the Relevant Percentage. The Relevant Percentage for a tax year is:

the rules-based rate (our jargon), while it applies for a member;

otherwise, it is the rise in the Consumer Prices Index (CPI) (the increase to the September preceding the tax year so 5.2% for 2012/13).

DB benefit accrual - the rules-based rate test

The rules-based rate is one that applies if and while an individuals benefits increase according to a specified rate under a provision in the rules that was in existence on 9 December 2010, providing that rule has not been changed since.

So who falls under the rules-based rate test?

Typically a