David Walker of Moore and Smalley looks at the new forms of protection in relation to the reduction in the Lifetime Allowance (LTA) from April 2014.
The LTA is the maximum amount of tax relieved pension savings one may make in a lifetime. If you go over the prescribed limit then the excess is taxed.
When looking at personal pensions, assessing the amount of the overall savings is easy enough. You merely look at the current value of the investments held. But for occupational pension schemes (sometimes called defined benefit arrangements), there is no pot of investments as such, so a different valuation method is required.
A capitalisation factor is used to achieve this. It is an attempt to work out what notional pot of money would need to be invested to provide similar benefits to those earned in the NHS Pension Scheme (NHSPS). A factor of 20 has been agreed, plus the lump sum if there is one. For instance:
Lump sum £201,000
Pension x 20 £1,340,000
Lump sum £201,000
Total capital value £1,541,000
The capital value as calculated above is measured against the LTA for the year. Any excess over the limit is taxable at 25%. The scheme will pay this on your behalf and will reduce the pension benefits to recoup the tax paid for you. This is a permanent reduction calculated by reference to a recovery over 20 years.
The capital value in this example is £41,000 above the current £1,500,000 limit. Tax due on the excess at 25% is £10,250, which the scheme will pay. Your pension will then be reduced by £512.50 a year gross (£10,250/20).
Probably being a 40% taxpayer in retirement, this equates to a net loss of £307.50 (£512.50 x 60%), or £25.62 per month.
LTA charges may, in some circumstances, be due at 55% and possibly 40%. Those occasions are fairly rare and not relevant here.
Changes from April 2014
From 6 April 2014, the LTA limit is due to fall from £1,500,000 to £1,250,000. Consequently, if you retired on 31 March 2014 with a capital value of your pension rights of £1,400,000, you would not suffer a charge.
But if you retired a week later at 7 April 2014, you would have an excess of £150,000 and a tax charge of £37,500. You are obviously badly disadvantaged if the above happens. People in this position are therefore to be given opportunities to take out protection to avoid paying the £37,500.
There are two new forms of protection to be offered: Fixed Protection 2014 and Individual Protection 2014.
Fixed Protection 2014 (FP14)
An application may be made before 6 April 2014 for FP14. The application form is available on HMRC’s website, or you can apply on-line. Upon the granting of FP14 you retain the higher limit of £1,500,000. Should your pension benefits exceed this when they are drawn, the excess will be taxed as above.
However, FP14 will be lost under certain circumstances, which means your LTA limit will revert to the standard LTA of £1,250,000. These circumstances are:
- A new arrangement is made (i.e. a new pension is commenced), or
- Benefit accrual occurs.
It is fairly easy to tell whether benefit accrual occurs under a personal pension arrangement. If you make a contribution, then benefit accrual has occurred and you lose FP14. To retain the higher limit, therefore, you must cease making contributions to all private pension arrangements.
But in a defined benefit scheme such as the NHSPS, when does benefit accrual occur? The first thing to be said is that continuing to contribute to the scheme does not in itself mean you lose the protection.
There are also provisions within the legislation for growth at an annual rate specified within the scheme rules to be permitted. There is no such rate within the NHSPS. Benefits increase by a combination of increased service, pay, or dynamisation.
The protection is lost if the capital value of your benefits, at any time in the tax year, grows by more than a permitted percentage. The permitted percentage is the increase in the Consumer Price Index (CPI) for the 12 months up to the September falling in the previous tax year.
So, for example, if you wish to judge the growth of your capital value in 2014-5, you measure it against the CPI growth for September 2013. The CPI for the year to September 2013 was 2.7%. If your capital value grows by more than that, then FP14 is lost and your limit reverts to the standard £1.25m.
For anyone in the NHSPS, particularly GPs, it is ridiculously easy to exceed growth of 2.7%. A GP with a dynamised pot of career earnings of, say, £1,500,000 with 18 years practitioner service and 22 years of total service would only need a dynamisation rate of 1.5% (the minimum it can be) and pensionable pay in the following year of £35,000 to exceed 2.7% growth in the capital value.
In my experience, such values together in one year would be rare. For it to happen over a number of years consecutively to retirement probably stretches the imagination.
FP14 can be lost at any time in the tax year. Once HMRC grants the protection, there is an obligation upon you to advise them of its loss within 90 days of that happening. Penalties may apply if you do not.
This means, therefore, that you must, at least every three months, value your benefits to see if benefit accrual has occurred. That could be both time consuming and costly.
Individual Protection 2014 (IP14)
This is a form of protection that was argued for before 2012, when the LTA reduced from its limit before then of £1,800,000 to the current level of £1,500,000. No such protection was provided at that time, so it is a welcome advancement, and almost unique, that the Treasury has actually listened to the critics and provided something which is remotely of any use.
IP14 can be applied for by anyone with benefits with a value of more than £1,250,000 at 5 April 2014. Should that be the case, you may continue to accrue benefits within your scheme, but you will have a personalised LTA limit set at the value of your benefits at 5 April 2014, subject to a maximum of £1,500,000.
To reach a capital value of benefits of £1,250,000 in, say, the 1995 side of the NHSPS, you will need a pension of £54,348, so we are mainly looking at older members who have been in the scheme for some time. The protection should be effective for such members and it means that you can carry on building your benefits after 5 April 2014.
If we follow the above example of a member with a 1995 pension of £67,000, with IP14 there would be tax payable on an excess over £1.5m of £10,250. Without the protection, there would be tax due on an excess over £1.25m of £72,750. Yes, another £62,500 of tax payable!
It is disappointing that the protection is restricted to only those with values above £1.25m. Opening it up to everyone in the scheme before the change would have been even better. The Government is, however, attempting to reduce a deficit, so someone has to pay the taxman.
To obtain IP14 you will need to have a valuation of your benefits performed at 5 April 2014 to ascertain whether they are over £1.25m. It will not be possible to value benefits at 5 April 2014 until after that date.
Unlike FP14, which must be applied for before 6 April 2014, applications for IP14 can only be made after that date. HMRC is proposing a window of three years in which you can apply.
Legislation upon the application of IP14 has not yet been passed, so final details are still unknown. As the figures above show, though, the tax saving with IP14 can be considerable and, as it is not very often that HMRC gives you something for nothing, it may well be advisable to take up the offer.
There are possible implications if you have an existing form of protection in place. You may not take out either FP14 or IP14 if you have Primary or Enhanced Protection in place. You can, however, apply for FP14 if you have FP12 in place, which preserved your limit at £1.8m, although why you would do that is a mystery.
You are able to have both FP14 and IP14 in place at the same time and can also have IP14 if you already have FP12. It is therefore quite flexible.
When should an Independent Financial Adviser (IFA) be involved? As we have seen, for FP14 to remain valid you must effectively cease contributing to your pensions. That obviously has a direct affect upon what you will live on in retirement and, as such, is a decision that should be taken with the appropriate IFA advice.
IP14, however, is a safeguard. It provides a best case scenario in the absence of other valid protections. If it works, you benefit. If it doesn’t, you are no worse off than if you hadn’t had it.
Whether you make an application does not, therefore, require any IFA input. A valuation of your benefits at 5 April 2014 will, however, need to be performed, so there may be additional costs if your accountant does this for you or prepares the application form.
The devil will no doubt be in the detail when it comes out. But the initial impression is favourable and applications should be encouraged.
The new 2015 NHS Pension Scheme
With a new NHSPS coming into being from April 2015, many GPs in existing 1995 and 2008 sides of the current arrangement are querying what impact the new scheme will have on them.
Those within 10 years of their normal retirement age as at 1 April 2012 are fully protected. That means that they will remain in their existing scheme until retirement and the 2015 scheme will have no bearing.
For those over 10 years from their normal retirement age, the 10 year full protection period is restricted by two months for every month they are over 10 years from their normal retirement age at 1 April 2012.