UK Pensions: Act now to avoid reduction in the lifetime allowance of tax free pension benefits

16 January 2012 |

From 6 April 2012 the lifetime allowance will be reduced by £300,000 to £1.5 million.  Pension benefits in excess of the lifetime allowance will be taxed at 55%.   Now is the time to consider ‘fixed protection’.

What is the lifetime allowance?

The lifetime allowance is the maximum amount, held in a registered pension scheme, which is eligible for favourable tax treatment.  Should the lifetime allowance be exceeded a tax charge is applied.

The tax charge

When the value of a person’s pension, as measured on the occurrence of specified events, exceeds the lifetime allowance the excess is subject to a 55% tax charge.  For example, if an individual has a pension worth £1.75 million, then on the first specified event after 5 April 2012 this will be subject to a tax charge of £137,500 (£250,000 x 55%).

As no plans for future increases of the lifetime allowance have been announced, it is possible that the £1.5 million limit may apply for the foreseeable future.  It is therefore likely that more and more people will be affected by the 55% tax charge.

While a lifetime allowance of £1.5 million may appear generous, it is surprising how quickly an already substantial pension, growing at, for example, 5% a year, will exceed the lifetime allowance.  Therefore individuals with large pension funds who are relatively young should consider their options prior to 6 April 2012.

Fixed protection

One way of avoiding this charge is by electing for ‘fixed protection’ (see Resources below for a link to HMRC’s guide).  This election must be made prior to 6 April 2012.  Once this election has been made then the individual’s protected allowance will remain at £1.8 million.  However, a consequence of the election is that no further benefits can be accrued in registered pension schemes.

Fixed protection can be lost in certain circumstances, including where additional contributions are made to a money purchase arrangement or if the individual transfers out of their scheme. Therefore, before electing for fixed protection individuals should understand what is and is not permitted.

As individuals who elect for fixed protection are unable to continue making pension contributions they should consider alternative investments for their retirement savings.

Fixed protection will not be the right option for everyone.  Individuals who are considering it should take into account the fact that electing for fixed protection would mean that their employer would be unable to continue contributing to their pension.

Before making any decisions on their pensions, individuals should take specialist advice.

Commentary

The purpose of the reduction in the lifetime allowance is to restrict pensions tax relief for the wealthy.  Those wishing to to mitigate the 55% tax charge should act now to gather sufficient information on all of their pension investments, to enable them to make an informed decision prior to the 6 April 2012 deadline for electing for fixed protection.

Resources

HMRC’s Guide on protection of the lifetime allowance and completing the relevant application form

For further information or to discuss the issues raised, please contact Guy Abbiss, John Mooney or Stephen Wright on +44 20 3051 5711.

Disclaimer

Content is for general information purposes only. The information provided is not intended to be comprehensive and it does not constitute or contain legal or other advice. If you require assistance in relation to any issue please seek specific advice relevant to your particular circumstances. In particular, no responsibility shall be accepted by the authors or by Abbiss Cadres LLP for any losses occasioned by reliance on any content appearing on or accessible from this article. For further legal information click here.

Circular 230 disclosure

To ensure compliance with requirements imposed by the IRS and other taxing authorities, we inform you that any tax advice contained in this article (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties that may be imposed on any taxpayer or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.

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