FOR ADVISERS ONLY
Primary and enhanced protection
It was possible for individuals of pension schemes set up before 6 April 2006 to protect the benefits they already had on 5 April 2006. There are 2 types of protection - primary protection and enhanced protection. Individuals had until 5 April 2009 to apply for primary or enhanced protection.
Primary protection - Individuals who had benefit values on 5 April 2006 of over £1.5 million could use primary protection to reduce or eliminate the chance a lifetime allowance charge could apply. The amount of tax-free cash they had already built up before 6 April 2006 could also be protected.
Enhanced protection - This can also protect the tax-free cash built up before 6 April 2006 and completely eliminate the risk of a lifetime allowance charge being due (as long as certain criteria are met).
Enhanced protection couldn't be sought for individuals with benefits over the pre 6 April 2006 HMRC maximums. If there was a surplus on 5 April 2006 this had to be dealt with before the individual could apply for enhanced protection. Primary protection could be applied for even if the limits were exceeded, but it was not possible to protect more than the HMRC maximum limit. The HMRC limit became the protected amount if the benefits were more than this limit on 5 April 2006.
The different types of protection are explained in more detail below:
Primary protection
This can be 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 will be used to calculate the individual's personal lifetime allowance when benefits are taken. Any amounts in excess of this will be 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 £1.8 million until such time as the lifetime allowance is greater than £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) then the amount payable will be the lesser of 25% of the benefit value and 25% of £1.5 million. Prior to 6 April 2014 it was 25% of the lifetime allowance when benefits were taken.
The tax-free cash will be protected as a monetary amount if it exceeded 25% of the lifetime allowance on 5 April 2006. From 6 April 2012 the amount payable will be the amount of tax-free cash available on 5 April 2006 increased by 20% until such time as the lifetime allowance is greater than £1.8 million when it will be indexed in line with increases to the lifetime allowance.
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 2022 = £2.65 million
Lifetime allowance in tax year 2022/23 = £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 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 2022 = £5.3 million
Lifetime allowance in tax year 2022/23 = £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 can only build up limited benefits in a registered pension scheme on or after 6 April 2006. Anyone who breaks these conditions, without advising HMRC, can face a financial penalty.
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
Tax-free cash can also be protected 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 benefits so when they come to take their benefits their tax-free cash will be based on the same percentage of their benefits value at crystallisation as it was on 5 April 2006.
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 LTA (£375,000) at that point enhanced protection of his tax-free cash applies. When he takes his benefits in 2022/23 his benefits are worth £1,950,000 and he is entitled to 31% tax-free cash, being £604,500.
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 LTA (£375,000) at that point he does not have enhanced protection for his tax-free cash entitlement. When he takes his benefits in 2022/23 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
Grant would be entitled to tax-free cash of £375,000.
Losing enhanced protection - what is treated as benefit accrual?
The following tables set out the circumstances in which individuals are treated as accruing further benefits in which case enhanced protection will be lost:
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. |
|
Benefits value on 5 April 2006 is expressed as a factor which is used to calculate the individual's personal lifetime allowance. The personal lifetime allowance will be increased by 20% until the lifetime allowance is greater than £1.8 million when it will be indexed in line with increases to the lifetime allowance. |
Unlimited fund growth protected for money purchase schemes (but no further contributions). Limited accrual protected for defined benefit/cash balance schemes. |
|
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, are able to 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. Details of how this works can be found in our article Protection of scheme specific tax-free cash.
Lifetime allowance charge
Details of how the lifetime allowance charge is calculated can be found in our lifetime allowance charge article.
Further information
Note
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 legislation 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.
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