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.
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.
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.