SLA bells ring, are you listening?

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(This article was last updated on 18 May 2016).

Our final technical article of 2015 takes a look at the drop in the standard lifetime allowance (SLA) that is due to take effect from 6 April 2016. The reduction, from £1.25m to £1m, will be the third one on the trot since the lifetime allowance peaked at its highest level of £1.8m in the 2010/11 and 2011/12 tax years. Overall, that represents a cut of more than 40% over that period of time.

It’s not all bad news though, as the lifetime allowance is set to increase in line with the Consumer Prices Index (CPI) from 6 April 2018. There will also be two new fund protection options introduced from 6 April 2016 to offer some transitional protection for people who think they will be affected by this latest reduction. These protections will be referred to as fixed protection 2016 (FP2016) and individual protection 2016 (IP2016). Legislation for both of these options is included in the Finance Bill 2016, and we’ll now go on to look at what we currently know based on the information contained in the Bill and in recent HMRC Pension Scheme Newsletters. 

FP2016 will fix an individual’s lifetime allowance at £1.25m. If the SLA increases above £1.25m sometime in the future (for example, through CPI increases), an individual’s FP2016 will stop and the higher SLA will then apply. FP2016 will work in much the same way as fixed protection 2012 and fixed protection 2014. 

If someone wants to apply for FP2016, they will need to stop contributions or stop accruing benefits with effect from 6 April 2016.

Any member of a registered pension scheme, who doesn’t already have primary protection, enhanced protection, fixed protection 2012 or fixed protection 2014 will be able to apply for FP2016. There will be no requirement to have a certain amount of pension savings to apply for FP2016.

FP2016 is likely to be suitable for individuals whose pension savings are expected to be above £1m when they take their pension benefits on or after 6 April 2016.

It will be possible for someone to hold FP2016 and also have IP2016 as a back-up. If IP2016 is held as a back-up to FP2016, the FP2016 will take precedence. IP2016 will only apply if the FP2016 is lost.

It will also be possible for FP2016 to be held as a back-up to IP2014. However, the FP2016 could only become relevant providing the FP2016 conditions could still be met at the time that IP2014 is lost or given up. 

When an individual takes their pension benefits with FP2016, they will be tested against £1.25m rather than the SLA of £1m, and the amount crystallised will be recorded as a percentage of £1.25m. If no tax-free cash protection applies, the maximum tax-free cash available will be the lower of: 

  • 25% of £1.25m, and
  • 25% of the remaining fund.

FP2016 will be lost if on or after 6 April 2016:

  • a new arrangement is set-up for an individual under a registered pension scheme other than to accept a transfer of their existing benefits
  • any transfer is made out of an individual's existing arrangement(s) that is not a 'permitted transfer' 
  • there is 'benefit accrual' under an arrangement for an individual in a registered pension scheme

If FP2016 is lost, it’s an individual’s responsibility to notify HMRC. They must do so within 90 days of losing the protection.

IP2016 will only be an option for those with pension savings (including any pensions already in payment) valued at more than £1m on 5 April 2016. 

Those with IP2016 will be given a protected lifetime allowance equal to the amount of their pension savings at 5 April 2016, capped at an overall maximum of £1.25m. The protected lifetime allowance will be quoted as a monetary amount and won’t change over time unless the SLA increases above it (for example, through CPI increases). If that happens, the IP2016 protection would cease to apply and the higher SLA will become relevant.

It will be possible for those with IP2016 to make further pension contributions or accrue additional defined benefits rights after 5 April 2016. However, these pension savings are likely to be subject to a lifetime allowance charge when benefits are taken if they exceed an individual’s protected lifetime allowance (or the SLA, if higher). 

IP2016 will be available for someone:

  • with pension savings on 5 April 2016 valued at more than £1m
  • with no existing fund protection
  • as a backup to enhanced protection, provided primary protection or individual protection 2014 isn't already held as a back-up
  • as a back-up to fixed protection 2012 or 2014, provided individual protection 2014 isn’t already held as a back-up
  • as a back-up to fixed protection 2016

In other words, it won’t be available if someone has:

  • primary protection
  • individual protection 2014

IP2016 will protect the value of a person’s pension savings on 5 April 2016 but the protection will be capped at the level of the 2015/16 tax year SLA of £1.25m. Any pension savings in excess of £1.25m can’t be protected under IP2016, and would be subject to a lifetime allowance charge when pension benefits are subsequently taken.

If IP2016 is held as a back-up to enhanced protection or one of the fixed protection options, the enhanced or fixed protection will take precedence. If either enhanced protection or fixed protection is lost, IP2016 will apply.

When an individual takes their pension benefits, they will be tested against their IP2016 protected amount rather than the SLA of £1m, and the amount crystallised will be recorded as a percentage of the protected lifetime allowance. If no tax-free cash protection applies, the maximum tax-free cash available will be calculated as the lower of:

  • 25% of the protected lifetime allowance, and
  • 25% of the remaining fund. 

The IP2016 option could be of benefit to:

  • anyone who wouldn’t receive another form of benefit from their employer if they chose to opt out of any further pension saving or benefit accrual after 5 April 2016. If their employer wasn’t willing to offer an alternative benefit, such as higher pay, it may be better for any employer contributions or benefit accrual to continue to be made, even though any additional savings could be subject to a lifetime allowance charge when benefits are eventually taken
  • anyone who wants to continue their pension savings after 5 April 2016, even though they may receive a protected lifetime allowance lower than the £1.25m lifetime allowance available through FP2016, and could incur a lifetime allowance charge on the additional savings or benefit accrual

The value of pension savings at 5 April 2016 can be split into four different categories:

  1. pensions that someone was receiving before 6 April 2006, valued at 5 April 2016.
  2. pensions put into payment between 6 April 2006 and 5 April 2016 along with certain tax-free lump sums received in the same period, valued at 5 April 2016.
  3. uncrystallised funds valued at 5 April 2016.
  4. pension savings in certain overseas pension schemes valued at 5 April 2016.

If a pension debit is made after 5 April 2016 to comply with a pension sharing order, a person’s protected lifetime allowance under IP2016 may be reduced or even cease to apply.

It is worth noting that, where a pension debit is made on or after 6 April 2017, the value of the pension debit is reduced by 5% for each full tax year elapsed between 5 April 2016 and the date of the pension debit. The resulting figure is then deducted from the individual's IP2016 protected amount. 

The onus is on an individual to tell HMRC if they have become subject to a pension debit. HMRC will then either:

  • issue a replacement certificate if the protected amount is reduced, or
  • revoke the IP2016 certificate if the value of a person’s pension rights following the pension debit fall below £1m at the time the pension sharing order takes effect.

The standard lifetime allowance will be increased in line with Consumer Prices Index (CPI) increases from 6 April 2018. If at any time, the standard lifetime allowance increases above the protected amount held under any of the fixed or individual protection options, the standard lifetime allowance will apply. This is, initially, only going to be relevant for those with a protected amount under IP2016.

For example, assume the increase in CPI from September 2016 to September 2017 is 2%. This would mean that the standard lifetime allowance for the 2018/19 tax year will be £1,020,000. So, anyone with a protected amount under IP2016 of less than this amount would see this amount be replaced by the 2018/19 standard lifetime allowance of £1,020,000 instead. 

It will not be possible for anyone to apply for FP2016 or IP2016 before 6 April 2016.

If someone wants to apply for FP2016, they will need to stop contributions or stop accruing benefits with effect from 6 April 2016.

Applications for both FP2016 and IP2016 will be made online to HMRC and will involve similar information and declarations as those made for FP2014 and IP2014. For IP2016, a valuation of all an individual's pension savings at 5 April 2016 will need to be made to set the protected amount. 

A protection reference number will be provided by HMRC and this number will need to be given to a pension scheme by an individual each time benefits are being taken where FP2016 or IP2016 are held. 

No paper protection certificate will be issued by HMRC for FP2016 and IP2016 and no application deadline will exist. However, individuals should apply to HMRC for FP2016 or IP2016 before they take their pension benefits as they will need the HMRC reference number if they want to rely on the protection.

There will be a period of three months between April 2016 and July 2016 where an interim process will need to be followed for those wanting to rely on FP2016 and IP2016 when they take pension benefits. This will involve:

  • individuals writing to HMRC between April 2016 and July 2016 to say they want to take benefits during that period and declaring they do not hold any existing form of protection that would prevent them from holding the new protection or protections
  • HMRC checking the information provided and responding to the individual in writing with a temporary reference number, which will only be valid until 31 July 2016
  • the temporary reference number provided by HMRC being sent to the pension scheme along with the other information needed to take pension benefits

Please note a full application for FP2016 or IP2016 will still need to be made online to HMRC after July 2016 even where an individual has used the interim process. This will result in a permanent reference number being issued, which will replace any temporary reference number that previously applied. 

Note - further information on the interim process, including wording for a person to use when making an interim application for FP2016 or IP2016 to HMRC, can be found in HMRC's Pension Schemes Newsletter 76

Temporary reference numbers will be in the format of AJ followed by four digits for FP2016 (eg, AJ1234) or four digits followed by AJ for IP2016 (eg, 1234AJ).

Permanent reference numbers will be in the format of FP16 followed by ten digits and one letter for FP2016 (eg, FP161234567890A) or IP16 followed by ten digits and one letter for IP2016 (eg, IP161234567890B). 

A protection reference number for IP2016 will not be issued by HMRC if IP2016 is being applied for as a back-up to enhanced protection or one of the fixed protection options. HMRC will instead inform someone if their application for IP2016 as a back-up has been successful. An IP2016 protection reference number will only subsequently be issued if enhanced or fixed protection is lost and the IP2016 becomes active.

HMRC have also said that they are investigating the possibility of introducing an online service for scheme administrators to check the protection status of their scheme members. They have promised to provide more information once they have reviewed all available options.

It’s worth pointing out that it is still possible for individuals to apply for individual protection 2014 (IP2014) up to 5 April 2017. To recap, IP2014 is only an option for those with pension savings (including any pensions already in payment) valued at more than £1.25m on 5 April 2014. IP2014 will protect the value of a person’s pension savings on 5 April 2014 but the protection will be capped at the level of the 2013/14 tax year SLA of £1.5m. Applications can be made online(Opens new window)(Opens new window) and there is an online tool on HMRC’s website to help individuals decide whether to apply for IP2014 which can be found at Lifetime Allowance Checking Tool(Opens new window)(Opens new window).

Summary

The planned introduction of FP2016 and IP2016 will offer some transitional protection to those that may be affected by the reduction in the SLA from 6 April 2016. Those intending to apply for either or both of these new protections will need to take steps to apply online to HMRC when the application process opens in July 2016 (or through the paper-based interim process, available from 6 April 2016, if they intend to take benefits earlier than this).

Those intending to apply for FP2016 will need to stop contributions or stop accruing benefits with effect from 6 April 2016.

Awareness of the options available will allow those potentially affected ‘to face unafraid, the plans that they’ve made’ so that they’re ‘walking in a pensions wonderland’.

Pensions Technical Services