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Primary and enhanced protection
It was possible to protect pension benefits built up before 6 April 2006 (A-Day) from a lifetime allowance charge by applying for primary and enhanced protection.
The lifetime allowance charge has been removed from 6 April 2023 and the lifetime allowance will be completely removed from 6 April 2024. From that date it is only the tax-free cash protection (if any) that is maintained by these protections, though there are restrictions that apply.
Let's look at the different types of protection in more detail:
Primary protection
This was used by individuals who had a benefits value on 5 April 2006 which exceeded the lifetime allowance of £1.5 million. These individuals could register their own personal lifetime allowance. This is expressed as a primary protection factor which is used to calculate the individual's personal lifetime allowance when benefits are taken. Prior to 6 April 2023 any amounts in excess of this was subject to a lifetime allowance charge.
Due to the reduction in the lifetime allowance, from 6 April 2012, the lifetime allowance used to calculate the level of personal lifetime allowance remains at £1.8 million.
Tax-free cash lump sum
If pre-6 April 2006 tax-free cash was less than £375,000 (25% of the lifetime allowance on 6 April 2006) the amount payable is the lesser of 25% of the benefit value and 25% of £1.5 million. Before 6 April 2014 it was 25% of the lifetime allowance when benefits were taken.
The tax-free cash is protected as a monetary amount if it exceeded 25% of the lifetime allowance on 5 April 2006. From 6 April 2012 the amount payable is the amount of tax-free cash available on 5 April 2006 increased by 20%.
Example 1 - Primary protection - tax-free cash less than 25% of lifetime allowance on 5 April 2006
Benefits value on 5 April 2006 = £2.25 million
Primary protection factor is therefore = £2.25 million - £1.5 million = £0.75 million/£1.5 million = 0.5
Benefits value in May 2023= £2.65 million
Lifetime allowance in tax year 2023/24 = £1,073,100
Primary protection maintains the lifetime allowance at £1.8 million
Personal lifetime allowance when benefits are taken = £1.8 million + (£1.8 million x 0.5) = £2.7 million
Tax-free cash
Tax-free cash on 5 April 2006 = £210,000 (primary protection does not apply to tax-free cash as it was less than £375,000)
Maximum tax-free cash when benefits are taken will be the lower of:
- 25% x £1.5 million = £375,000, and
- 25% of £2.65 million = £662,500
The maximum tax-free cash is therefore £375,000.
The individual's benefits value exceeds the lifetime allowance in the year in which they take their benefits. But, as they opted for primary protection, a personal lifetime allowance applies. The individual's personal lifetime allowance is greater than the benefits value when they are taken so no lifetime allowance charge is due.
Example 2 - tax-free cash of more than 25% of lifetime allowance on 5 April 2006
Benefits value on 5 April 2006 = £4.5 million
Primary protection factor is therefore = £4.5 million - £1.5 million = £3 million/£1.5 million = 2
Benefits value in July 2023 = £5.3 million
Lifetime allowance in tax year 2023/24 = £1,073,100
Primary protection maintains the lifetime allowance at £1.8 million.
Personal lifetime allowance when benefits are taken = £1.8 million + (£1.8 million x 2) = £5.4 million
Tax-free cash
Tax-free cash on 5 April 2006 = £840,000
Maximum tax-free cash when benefits are taken will be: £840,000 x 120% = £1,008,000
Again, no lifetime allowance charge is due as the personal lifetime allowance exceeds benefits value when they are taken.
Enhanced Protection
This applies to individuals who wanted full protection from the lifetime allowance charge when they come to take their benefits. Enhanced protection allows the pension fund to grow to any amount without it being subject to the lifetime allowance.
Anyone who selected enhanced protection had to stop paying into any money purchase scheme (excluding any on-going contracted-out payments to an existing scheme) prior to 6 April 2006. Members of defined benefit schemes or cash balance arrangement could only build up limited benefits in a registered pension scheme on or after 6 April 2006. Anyone who breaks these conditions, prior to 6 April 2023, without advising HMRC, could have faced a financial penalty.
Since 6 April 2023 the restriction on paying contribution/benefit accrual has been removed and would not trigger the loss of enhanced protection.
There was no minimum benefits value to register for enhanced protection. An individual who applied for enhanced protection could also apply for primary protection if their benefits value exceeded £1.5 million on 5 April 2006.
Tax-free cash
An individual could also protect their tax-free cash using enhanced protection.
An individual with an entitlement to tax-free cash of more than 25% of the lifetime allowance (£375,000) and more than 25% of the fund on 6 April 2006 could protect their tax-free cash entitlement.
If they took their benefits before 6 April 2023 their tax-free cash was based on the same percentage of their benefits value at crystallisation as it was on 5 April 2006.
Since 6 April 2023 their tax-free cash is also based on the same percentage of their benefits value at crystallisation as it was on 5 April 2006. However, the percentage is applied to the lower of
- their total benefits value on 5 April 2023, or
- their total benefit value at crystallisation.
An individual with an entitlement to tax-free cash of more than 25% of their benefits value on 6 April 2006 but less than 25% of the lifetime allowance on 6 April 2006 (£375,000) couldn't protect the tax-free cash amount using enhanced protection. However, scheme specific tax-free cash protection may apply.
Example 1
Thomas had benefits of £1,300,000 on 5 April 2006. His tax-free cash entitlement was £400,000 (31%). As his tax-free cash on 5 April 2006 was greater than 25% of the lifetime allowance (£375,000) enhanced protection of his tax-free cash applies.
If he took his benefits in November 2022 when his benefits are worth £1,950,000 and he's entitled to 31% tax-free cash, being £604,500.
If he took his benefits in August 2023 when his benefits are worth £2,300,000 and they were worth £2,050,000 on 5 April 2023 he’s entitled to 31% tax-free cash of £635,500 (being £2,050,000 x 31%).
However, If he took his benefits in December 2023 when his benefits are worth £1,850,000 and they were worth £2,050,000 on 5 April 2023 he’s entitled to 31% tax-free cash of £573,500 (being £1,850,000 x 31%).
Example 2
Grant had benefits of £1,400,000 on 5 April 2006. His tax-free cash entitlement was £280,000 (20%). As his tax-free cash on 5 April 2006 was less than 25% of the lifetime allowance (£375,000) he doesn't have enhanced protection for his tax-free cash entitlement. When he takes his benefits in 2023/24 his benefits are worth £2,000,000 and he is entitled to an amount of tax-free cash, of the lower of:
- £500,000 being 25% of £2,000,000
- £375,000 being 25% of £1,500,000
This means Grant is entitled to tax-free cash of £375,000.
Losing enhanced protection - what is treated as benefit accrual?
Since 6 April 2023 it has not been possible to lose enhanced protection as the paying contributions/benefit accrual restrictions have been removed.
The following tables set out the circumstances prior to 6 April 2023 where individuals are treated as accruing further benefits and they will lose their enhanced protection:
Money purchase
| Type of benefit | Treated as accruing further benefits |
|---|---|
| Money purchase (other than cash balance) benefits | Any contribution paid by the employer, the individual or someone on behalf of the individual excluding any ongoing contracted-out rebates to a scheme that existed on 5 April 2006. |
Defined benefits and cash balance benefits
Unlike money purchase schemes where benefit accrual is based on contributions paid, defined benefit and cash balance accrual is checked when benefits are paid out or on transfer. Contributions to these types of scheme will not automatically trigger the loss of enhanced protection.
| Type of benefit | Treated as accruing further benefits |
|---|---|
| Defined benefits |
|
| Cash balance benefits | If the individual's benefit increases by the greater of 5% and RPI between 6 April 2006 and the date benefits are taken. |
Enhanced protection - maximum salary increases for defined benefit and cash balance schemes
Although individuals can only build up limited benefits under a defined benefit scheme or a cash balance arrangement on or after 6 April 2006 the eventual benefit paid will not be linked to earnings on 5 April 2006. Provided earnings don't increase by too much the individual will continue to benefit from salary growth (for as long as they remain in the employer's service) while protecting all of their benefits from the lifetime allowance charge.
| Pre 6 April 2006 tax regime | Maximum earnings increase |
|---|---|
| Pre 1987 member and 1987- 1989 member (non-capped) |
The lower of:
|
| Post 1989 member (capped) |
The lower of:
|
A summary of the 2 different types of protection:
| Primary | Enhanced |
|---|---|
| The individual's benefits value on 5 April 2006 had to exceed £1.5 million. | The individual could protect any amount with no possibility of a lifetime allowance charge. |
| Can make future contributions. | All contributions to money purchase schemes had to cease before 6 April 2006 and there can only be limited accrual under defined benefit/cash balance schemes from 6 April 2006, the only exception being any contracted-out rebates to a scheme that existed on 5 April 2006. From 6 April 2023 this restriction no longer applies |
|
Benefits value on 5 April 2006 is expressed as a factor which is used to calculate the individual's personal lifetime allowance. Any protected tax-free cash amount will be increased by 20%. |
Unlimited fund growth protected for money purchase schemes (but no further contributions). Limited accrual protected for defined benefit/cash balance schemes. Any protected tax-fee cash percentage is applied to the lower of:
|
| May attract a lifetime allowance charge on excess above personal lifetime allowance. | May revert to primary protection if enhanced protection lost (if registered for primary protection as well). |
No protection
Individuals who didn't opt for transitional protection, but who had the right to more than 25% of their benefits value at 5 April 2006 as tax-free cash, can have a protected amount of tax-free cash paid when they take their benefits and, depending on fund growth, additional tax-free cash based on post 6 April 2006 benefits. You can find details of how this works in our article Protection of scheme specific tax-free cash.
Lifetime allowance charge
The lifetime allowance charge has been removed from 6 April 2023 and the lifetime allowance will be completely removed from 6 April 2024.
Disclaimer
The information provided is based on our current understanding of the relevant legislation and regulations and may be subject to alteration as a result of changes in legislation or practice. Also it may not reflect the options available under a specific product which may not be as wide as legislations and regulations allow.
All references to taxation are based on our understanding of current taxation law and practice and may be affected by future changes in legislation and the individual circumstances of the investor.