The fundamentals of fixed protection
It’s no longer just the super-rich who need to be concerned about the Lifetime Allowance (LTA). A pension value which might appear modest today could be on track to breach the LTA by the time the individual retires. Regular contributions made by individuals and employers, coupled with compounding interest and investment growth, can push a pension value into the danger zone.
Each time the LTA has been reduced, new forms of protection have been made available. The last change was made in April 2016, when the allowance was reduced from £1.25 million to £1 million.
Applications are still open for FP16, which provides a fixed LTA of £1.25 million. No deadline has been set and it is still possible to apply for those who haven’t saved into a pension since.
Late application for earlier forms of protection
Ordinarily, for HMRC to allow a late application, the individual must be able to satisfy two limbs of the statutory test. Limb one is reasonable excuse and limb two is reasonable delay. Application deadlines for FP12 and FP14 have now closed but three tribunal cases from recent years illustrated how the statutory test is applied in practice and whether a late application for protection can still be made: Twaite v HMRC, Tipping v HMRC and Jackson v HMRC.
It is worth noting these cases relate to the late application of enhanced protection rather than fixed protection; although I would hope HMRC would apply its discretion consistently, we are yet to see if this is the case.
Individuals continue to accidentally make contributions after applying for fixed protection. Therefore it’s important to check clients understand and contributions are not re-started as this mistake can be costly and result in the protection being revoked.
If an individual mistakenly makes a contribution into their pension, ordinarily it could not be refunded, meaning protection is lost. If, on the other hand, the individual instructed their employer or bank to cancel the same payment and they did not do so, then that contribution could potentially be refunded under HMRC genuine error rules.
Interestingly, in the Hymanson v HMRC case – where Mr Hymanson forgot to cancel his direct debit – the judge ruled against HMRC and that the protection must be reinstated. Whilst this pragmatic ruling is refreshing, it doesn’t necessarily mean the outcome can be applied on a wider basis.
Consumer Prices Index (CPI)
When the LTA increases to more than the protected amount, protection will be lost and the individual’s LTA will be the standard higher LTA. This should take approximately nine years based on an average CPI increase of 2% per year, showing the value of existing protection.
Falling foul of auto enrolment (AE) rules whilst holding protection can be an expensive oversight. Industry experts believe it’s likely a large number of individuals have revoked their protection by failing to opt out of their workplace scheme within the one month cooling-off period. Approximately 7,000* breaches have been recorded since the introduction of AE, with a particular spike after 2017 coinciding with the roll-out of reforms to smaller businesses.
*Freedom of information request submitted by AJ Bell.
At what can be a very difficult time, further turmoil is unwelcome. A deduction of a pension debit from a member’s pension will not result in the loss of FP16, so the remaining funds will continue to be protected. Although, if the member elects to make contributions to build up the pension again, the protection would be revoked as this is classed as benefit accrual.
On the other hand, if an ex-spouse or ex-civil partner with FP16 receives a pension credit, they could lose their protection if the transfer is made to a new arrangement, as this would not be a permitted transfer. If the pension credit is paid to an existing arrangement which is a money purchase arrangement, FP16 would not be lost. If it is made to a defined benefit arrangement, FP16 may be lost but this would only be determined when the benefit accrual for the tax year is calculated.
Benefit Crystallisation Events
Whilst it is preferable to have protection in place before benefits are taken, this cannot always be the case. Irrespective of the date FP16 is applied for, the protection is effective from 6 April 2016.
If an individual has taken benefits before applying for FP16, any Benefit Crystallisation Events (BCEs) after 6 April 2016 will need to be revisited using £1.25 million LTA instead. That applies to all pension providers where a BCE has taken place. Also worth noting is that, if a client takes protected tax-free cash which results in an overpayment, this could be an unauthorised payment.
Savers must adhere to HMRC’s rules, which in relation to the pension’s landscape can be extremely difficult to navigate. Legislation should be simplified to help savers contribute towards their retirement without being penalised unnecessarily.