Navigating the Lifetime Allowance and Pension Protection maze
The Lifetime Allowance is a combined limit on the total amount of pension benefits which an individual may build up in pension schemes. Up to the quantum of the Lifetime Allowance benefits may be taken as a lump sum or as pension income without triggering a tax charge. For the purposes of the Lifetime Allowance a calculation of NHS scheme benefits is made. If an individual’s pension benefits from one or more sources exceed the Lifetime Allowance then a tax charge is rendered on the excess above the limit on the following basis:
- 55% if taken as a lump sum; or
- 25% where the excess is taken as pension income.
The 25% charge on income feels favourable but let’s consider this a little further. For every £100 of excess benefits taken as income the 25% Lifetime Allowance charge is paid at 25%, leaving the pensioner with taxable pension income of £75. In the hands of a higher rate taxpayer the £75 taxable pension income is subject to income tax, currently at a 40% rate, equivalent to £30 and leaving net after tax income of £45. For a higher rate taxpayer the net position is therefore the same whether lump sum or pension income is taken from the excess.
The Lifetime Allowance was introduced in 2006 at a level of £1.5m and increased in each year until 2010 when it peaked at £1.8m. Since 2010 reforms have seen the limit on a downward trajectory. Recent changes have seen a reduction from £1.5m to £1.25m on 5 April 2014, and then from £1.25m to £1m from 5 April 2016.
The capital value of your NHS pension benefits is calculated by applying a factor of 23 to your pension. You might also have personal pensions alongside your NHS benefits. Doing the maths, if an individual has an annual NHS pension at retirement of more than £43,478 then they will have pension benefits above the Lifetime Allowance.
Protecting benefits above the current £1m Lifetime limit
Reductions in the Lifetime Allowance have been introduced retrospectively. This was seen as being unfair for individuals who, in saving for their retirement, have made decisions about the level of their pension contributions with higher Lifetime Allowance limits in mind. As a concession and recognising this HMRC offer some “protection” allowing an individual to retain a personal Lifetime Allowance limit above the current £1m.
There are several different forms of pension protection available including primary, enhanced, fixed and individual protections. So this is an area that is far from straight forward and advice should be sought from your advisers around available protections.
If you have not applied for any form of protection in the past your protection options will be limited. In all likelihood you will be restricted to applying for one of the Individual Protections which are available; either Individual Protection 2014 (IP14) or Individual Protection 2016 (IP16). These schemes of protection are specific to the reductions in the Lifetime Allowance limit at 6 April 2014 and 6 April 2016 respectively.
IP14 is available to an individual whose pension benefits at 6 April 2014 exceeded the new reduced £1.25m Lifetime Allowance limit introduced on that date. An individual with a projected pension of say £56,500 at 6 April 2014 would have pension benefits totalling £1,299,500 (23 x £56,500). An application for IP14 would protect their individual Lifetime Allowance at this higher £1,299,500 level, £49,500 above the Lifetime Allowance at that date.
IP16 is available to an individual where pension benefits at 6 April 2016 exceed £1m. An application for IP16 would protect the higher level of pension benefits.
Applications for IP14 and IP16 are time limited and must be made within 3 years of the date of change of the Lifetime Allowance. IP14 applications must therefore be made by 6 April 2017 and IP16 by 6 April 2019.
Next time you receive information about your pension savings from NHS Pensions don’t make the mistake of simply filing it away. Our practice is to request information annually for all of our GP clients. Up-to-date figures allow us to proactively plan and ensure available protections are applied for. Miss one of the deadlines for a protection application and you may well be faced with a tax charge that was totally avoidable.
For further information, please send us an enquiry.