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DB pension transfers – potential loss of LTA protection

When might a client undertaking a DB pension transfer lose their fixed or enhanced protection in respect of the Lifetime Allowance? ATEB Consulting’s Steve Bailey posed the question to Paul Clark, director of RussellDene Consulting, who specialises in pension and tax related matters.

At ATEB Consulting, we have had a few queries recently around when a client might lose protection in the event of a DB pension transfer. A number of advisers are concerned whether a DB scheme offering an enhanced transfer value will result in their client losing an election for either enhanced protection or any of the forms of fixed protection. We asked Paul Clark of RussellDene Consulting to share his thoughts around this aspect.

Paul says:

This is actually a complex area, but in simple terms:

• The test to see if enhanced/fixed protection is lost, is a test undertaken by the DB scheme administrator, based upon the accrual under the scheme immediately prior to the calculation of the CETV. Provided the DB accrual hasn’t resulted in the loss of protection then one needs to consider the transfer value.

• Provided the transfer value is a CETV, i.e. an actuarially calculated value reflecting the benefits being given up under the DB scheme, this will not result in the loss of enhanced/fixed protection. The issue is, what does anyone mean by an “enhanced CETV”?

To consider this in more detail, we can consider the position of an individual who has enhanced protection (please note the rules relating to fixed protection are slightly different, but the position in respect of the transfer value is the same) and is transferring from a defined benefit (DB) to a defined contribution (DC) arrangement.

• PTM (Pensions Tax Manual) 092420 sets out the circumstances in which enhanced protection can be lost by an individual.

PTM092430 confirms that there are two tests to be undertaken to ascertain if there has been “relevant benefit accrual” depending upon the nature of the scheme; in a
– defined contribution” arrangement, which the legislation refers to as an “other money purchase arrangement”, e.g. a SIPP;
– defined benefits arrangement, i.e. a final salary scheme.

It is important to understand that these are two separate tests. The former is based solely upon whether or not there has been any “relievable pension contributions” (see PTM000001) under the arrangement and has nothing to do with the monetary value of the underlying fund. The latter is based purely upon the value of the accrued rights under the scheme.

So, the test for “relevant benefit accrual” is made at the point of either the benefits in the DB crystallising or being transferred. PTM092420 confirms that if DB rights are transferred to an “other money purchase arrangement” the DB rights are assessed to see if there has been any relevant benefit accrual. Provided the transfer value offered by the scheme administrator is the “actuarial equivalent” value of the DB rights that have been tested, it does not matter what the monetary amount of the CETV is, so long as it is an actuarial equivalent.

Relevant Benefit Accrual Under a DB Arrangement

The concept of “relevant benefit accrual” is complex and there are two main tests that can be undertaken to ascertain if there has in fact been relevant benefit accrual within a DB scheme, effectively whether the benefits have increased by more than the “appropriate limit”. This is the greater of two values:

• the indexed amount;

• the earnings recalculation amount.

However, for most clients, the test most likely to be beneficial is the “indexed amount” test. In each of the years since A-Day, the index used is 5%. So, in the 10 tax years following on from A-Day (i.e. up to 5 April 2016), DB rights could have increased by 162.89%, i.e. 1.05 10.

The transfer value

In simple terms, one of the principles underlying DWP legislation on pension schemes is the requirement under English & Welsh trust law that beneficiaries must be treated fairly. This means that if a transfer value offered to one individual has been calculated in a more (or less) generous manner than those calculated for other members of the scheme, there are issues under DWP (as opposed to HMRC) pension legislation. This would have serious consequences for the pension scheme and for the trustees personally. Accordingly, scheme actuaries undertake calculations to prove that members are being treated fairly. So long as the transfer value has been calculated by the scheme actuary and, in their view, represents the actuarial equivalent of the DB rights being surrendered on transfer, HMRC will have no issue with the monetary value of the amount transferred from the DC scheme to a DC scheme; see PTM092420. There is nothing wrong with a sponsoring employer asking the scheme actuary to make assumptions for every member who is having CETVs calculated that are more generous and will result in a higher CETV, so long as the actuary can sign off that the transfers are still calculated in accordance with the CETV requirement. So, using a lower discount rate, or assuming a higher level of revaluation in deferment would both increase a CETV.

However, if the CETV has been calculated by the scheme actuary, and that transfer value is then enhanced by way of additional funding being made available (probably) by the sponsoring employer, it is that enhancement which would be treated by HMRC as resulting in the loss of enhanced/fixed protection, as by definition, the transfer value being offered is greater than the actuarial equivalent.

So, the crux of the matter is to understand what is meant by an “enhanced CETV”.

When the transfer is received by the DC arrangement

Once the benefits are received into the DC Arrangement (e.g. a SIPP or PPP) the only test for “relevant benefit accrual” to be undertaken at any future date is a test to see if there has been any “relievable pension contributions” under the arrangement since it was established; a “permitted transfer” is not a “relievable pension contribution”.

To quote HMRC: “Essentially the relevant benefit accrual test for other money purchase arrangements is an input test. So, payment of benefits from this type of arrangement will not trigger loss of enhanced protection.”

ATEB’s experience

Most of the issues we find with transfer advice relate to general suitability and compliance aspects. However, there are times when a technical issue like loss of protection can result in a suitability problem, especially if it is an issue that only comes up occasionally. Firms need to ensure that advisers look out for these potential pitfalls and factor them in to the advice when required.

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