Protection against LTA 2016 and HMRC latest on April-July ‘interim process’
David Trenner, technical director, Intelligent Pensions, looks at LTA protection 2016 and the interim process available from April-July 2016
When pensions simplification was introduced in April 2006, the purpose was to have a single set of tax rules for pensions that made it easy for the industry and for pension savers. But, in reality, the need for transitional protections to guard against the lifetime allowance charge just meant pensions remained as complicated as ever. The situation has also been made progressively worse with the Coalition Government reducing the lifetime allowance (LTA) in both 2012 and 2014 and the Tories attacking it again in the July 2015 Budget, so that it is about to be reduced for a third time from April 2016 to £1m.
It is increasingly important that advisers have a good understanding of how LTA protections work and how they can help their clients avoid paying unnecessary tax on their pension savings.
How pensions are measured against the LTA
When a pension scheme member becomes entitled to draw benefits from a registered pension scheme, they use up a proportion or percentage of their lifetime allowance. That is how the lifetime allowance test works, by reference to percentages of the individual’s lifetime allowance used up in particular circumstances.
There is no measure, for lifetime allowance purposes, of any benefits held by the individual until entitlement to those benefits arises. The main exception to this rule is where the member reaches age 75 without having taken benefits, and any undrawn entitlement is tested for lifetime allowance purposes at that time.
In addition, where the member reaches age 75 having previously designated funds after 5 April 2006 in a money purchase arrangement as available for the payment of drawdown pension (known as unsecured pension before 6 April 2011), the amount by which the value of their drawdown pension fund at that time exceeds the value of the funds previously designated is tested for lifetime allowance purposes. In other words the growth in excess of what they have withdrawn is tested.
The circumstances where a lifetime allowance test occurs are referred to in the legislation as benefit crystallisation events (BCEs). At each BCE a capital value is attributed to the benefits that crystallise. This capital value (the amount crystallising) is converted into a percentage of the standard lifetime allowance for the tax year in which the BCE occurred.
The percentage of the member’s lifetime allowance being used up as a consequence of a BCE is added to any percentage used up previously by the member, whether under the same scheme or a different registered pension scheme. Where the total of these percentages exceeds 100% of the individual’s lifetime allowance, the excess (or the chargeable amount) is subject to a specific tax charge (the lifetime allowance charge). There are different rules for pensions already in payment in April 2006 (known as pre-existing pensions) and for pensions commencing after 5 April 2006. There are also different rules for different types of pension.
How payments in excess of the LTA are taxed
The tax payable depends on whether the excess is taken as cash or as income. Under occupational schemes the administrator decides how the benefit will be paid and taxes it accordingly. The rates of tax are 55% for lump sums and 25% for income.
For an additional rate taxpayer the income tax rate will be 45% in additional to the 25% LTA tax, giving a total rate of 58.75%. Conversely a basic rate taxpayer (albeit unlikely to be paying basic rate and facing a LTA charge) would only pay 40% in total.
Individual protection 2014 is still available for anyone who had more than £1.25m in pensions on 5 April 2014. An application can be made using forms on HMRC website before 6 April 2017. Individual Protection 2016 and Fixed Protection 2016 applications cannot be made before July 2016, except by using the ‘interim process’.
From April 2016 there will be two protection regimes available, Individual Protection 2016 (IP2016) and Fixed Protection 2016 (FP2016). There will be no application deadline for these protections however, individuals will need to apply for protection before they take any of their benefits either on or after 6 April 2016, as they will need the HMRC reference number if they want to rely on the protection. If the individual does not have the reference number then the amount of the benefit crystallisation event will be expressed as a percentage of £1 million, rather than the higher protected LTA.
HMRC is introducing a new online self-service for pension scheme members to apply for protection and this service will be available for members to use from July 2016. Members will no longer receive a lifetime allowance protection certificate, instead once they have successfully applied for protection the online service will provide them with a reference number which they will need to keep. HMRC is also introducing an online service for scheme administrators to check the protection status of their scheme members. More information on this will follow “in due course”.
Latest on interim applications April – July 2016
There will be a period between the new protection regimes becoming available in April 2016 and the introduction of the new online self-service in July 2016. For this period HMRC will introduce an interim process for pension scheme members who want to take benefits before the introduction of the new online service.
Scheme members cannot apply for FP2016 or IP2016 before 6 April 2016 because as part of the application members must either:
• provide certain values as at 5 April 2016 relating to their pension savings (for IP2016)
• declare that they don’t hold other protections (enhanced protection, primary protection, fixed protection or fixed protection 2014) before 6 April 2016 (for FP2016)
In its Pension schemes newsletter 76 – February 2016, HMRC clarified the position with regard to the interim process.The newsletter states:
“Members who are not planning to take benefits between 6 April 2016 and July 2016 should wait and apply for protection using the online digital service which will be available in July 2016. This is because everyone who protects their pension savings temporarily must make a full online application from July 2016 and receive a permanent reference number to ensure their pension savings continue to be protected from the lifetime allowance tax charge.
We are aware that some members affected by the reduction in lifetime allowance will want to or need to retire on or immediately after 6 April 2016 and that these members may not have received their temporary reference number, confirming protection, from HMRC.
Members in this situation may wish to:
• postpone taking their benefits until they have received a temporary reference number from HMRC or
• take benefits up to the standard lifetime allowance and defer taking their remaining benefits until they have received a temporary reference number from HMRC.
Alternatively scheme administrators can test members benefits against the standard lifetime allowance of £1m, pay the tax charge on the accounting for tax (AFT) return and once the temporary reference number is obtained, re-calculate and then submit an amended AFT return to receive a repayment.”
Pensions Simplification was well intended but the need to protect people from retrospective legislation and the wish of politicians to keep making headlines for themselves has meant that instead of having multiple regimes, as we did before 2006, we now have multiple protections within the one regime making life every bit as complicated as it was before!
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