By Vikki Massarano, Partner, Arc Pensions Law
A variety of different protections were introduced in recent years as the lifetime allowance was reduced, in order to protect those whose pensions had already, or were likely to, exceed the lifetime allowance at the time. Fixed protection gives those who benefit from it a lifetime allowance which is substantially higher than the current standard lifetime allowance - Fixed protection was set at £1.8 million in 2012, £1.5 million in 2014 and £1.25 million in 2016. This provides a significant benefit in terms of taxation for members, but comes subject to certain conditions.
These valuable protections can be lost in certain situations, such as where there’s any benefit accrual, or where a transfer which is not a “permitted transfer” is made. HMRC has now taken the view that a buyout may not be a permitted transfer for a pensioner member, which could therefore cause the member to lose fixed protection. Deferred members and other forms of protection are not affected in the same way.
The original purpose of introducing fixed protection for members was to protect savers who had accumulated more than the reduced lifetime allowance from unexpected tax charges. Regulations specifically provide that enhanced protection, and fixed protection for deferred pensioners is not lost on a buyout. The position of pensioners with fixed protection appears to be an anomaly as it is difficult to think of any sensible justification for the law to treat them differently to other members on a buyout.
Moving to buy out a defined benefit pension is typically regarded as being a good thing for members, across the pensions industry as a whole. Aiming for buyout is a medium to long term strategy for many schemes. Trustees and employers are therefore understandably keen to continue to progress buyouts where possible, but without triggering negative tax consequences for their members with fixed protection.
Despite industry lobbying of HMRC to address this anomalous situation, a change in the law to prevent such tax liabilities arising seems unlikely to be implemented any time soon. As a result, trustees, employers and insurers are now exploring alternative ways to ensure that buyout activity can continue unimpeded by tax risk. One proposed solution involves a two-stage process, rather than the previous one stage conversion of buy in to buy out.
Essentially, this workaround involves the affected individual policies being issued to the trustees, before then being transferred to members. Other options being considered may include buying out benefits for members other than those affected by this issue, while continuing to operate the scheme for pensioner members with fixed protection. In any event, clear communication with affected members will be key.
Fortunately, the number of defined benefit scheme members who may be affected by this issue should be relatively limited. In order to be affected, members have to:
1. have fixed protection (and not have used all that fixed protection);
2. have benefits which are already in payment in the scheme being bought out; and
3. have benefits not yet in payment in another scheme.
Trustees are likely to want to take steps to identify all members who could be affected by this issue. Although we think of members with fixed protection as being members with higher benefits, of course pensioners with a small benefit in one scheme may have significant undrawn pensions in another. Members who are not pensioners at the start of the buyout process but who take their pension before buyout could also be caught, which means that trustees will have to spread the net even more widely to identify all members at risk.
Given the complexity of the law in this area, and the ambiguity surrounding the relevant issues, trustees should seek professional advice as to how to proceed. Dealing with this issue could cause delays in the buy out process, which should be factored into planning and timelines at an early stage where buyouts are being considered. .
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