Case study: individual protection 2016 pitfall

The case

Barry Brown has an untouched SIPP worth £1,800,000. He has no other pensions, and has not used up any of his lifetime allowance.

In 2016, he applied for individual protection 2016 when the lifetime allowance dipped to £1,000,000 and the value of his SIPP was £1,010,000. He then continued to contribute to his SIPP for another couple of years.

He now wants to access his pension, and take his full, tax-free cash.

Barry turns to his financial adviser for some help. He wants to know whether his tax-free cash is worth £450,000 (25% of the pot) or whether it’s less than this.

The prescription

Barry’s financial adviser starts by explaining that the pension tax rules have recently changed.

From April 2024, people have a limit on the tax-free lump sums they can take in their lifetime, including the pension commencement lump sums received when they access their pension, and the tax-free part of an ad-hoc lump sum (uncrystallised funds pension lump sum). This lump sum allowance is usually set at £268,275.

There is another important limit. The lump sum and death benefit allowance limits the tax-free lump sums the member receives during their lifetime, plus the tax-free lump sums their beneficiaries receive on their death. This is usually set at £1,073,100.

The new rules allow those who previously applied for transitional lifetime allowance protection to possibly get higher allowances. For example, someone who applied for individual protection 2014 when their pension pot was worth £1,400,000, would have a lump sum allowance of £350,000 and a lump sum and death benefit allowance of £1,400,000.

Individual protection works by freezing an individual’s allowances, based on the value of their pensions on 5 April 2014 (for individual protection 2014) or 5 April 2016 (for individual protection 2016). That normally results in higher allowances, but the situation is slightly different for those who secured individual protection 2016 when the value of their pension benefits was below the last lifetime allowance of £1,073,100.

As the lifetime allowance began to creep upwards again, it became apparent that someone in this position would be better off without the individual protection. But an individual is unable to revoke individual protection voluntarily.

The rules had been written to take account of this. If the lifetime allowance was higher than the pension fund protected, then the individual protection would stop applying, and instead the current lifetime allowance limits would kick in.

Barry asked if that was the current situation. As his individual protection was less than the lump sum and death benefit allowance, would these current allowances apply to him instead?

His financial adviser answered, unfortunately, no.

The new rules hadn’t been written with such a caveat in them. So, if Barry took his individually protected pension pot today, his maximum lump sum allowance would, in fact, be £252,500 (25% of £1,010,000). If the caveat still existed, he could have had a tax-free lump sum of £268,275; £15,000 more allowance.

But there was good news and bad news.

The good news was that HMRC has realised its oversight. It is currently drafting regulations to correct some of the details of Finance Act 2024, and one of these regulations will cover this position. It will be corrected in the future, and Barry will be able to take his full £268,275 tax-free cash, meaning he is no worse off than if he had crystallised his benefits before 6 April 2024.

The bad news was that there is no date yet for when these correcting regulations will take effect. The industry hopes they will be laid in the early Autumn, and then they will take effect three weeks after that.

So, if Barry wants his full tax-free cash, he will have to wait until that date before accessing his pension pot.