The end of transitional rules for pre A-Day pensions?

The pensions regime received a radical overhaul with effect from 6 April 2006. As the three year transitional period comes to an end on 5 April 2009, what action is required now in order to protect pre 'A-Day' rights?

What happened on 6 April 2006?

The new pensions tax regime which came into effect on 6 April 2006 ('A-Day') introduced a new set of rules applying to all approved pension schemes, both occupational and personal. The new rules limit the value of pension benefits an individual can accumulate within one or more 'registered' pension schemes during their lifetime before a tax charge is incurred. This limit is known as the 'lifetime allowance' (LTA).

The LTA was introduced at a level of £1.5 million for the first tax year, 2006/2007. It increases annually and is £1.65 million for the 2008/2009 tax year rising to £1.8 million for the 2010/2011 tax year. In the 2008 Pre-Budget Report it was announced that the LTA is then to be capped at this amount until 5 April 2016.

The capital value of any pension benefits drawn that exceed the LTA, including the capital value of benefits previously drawn from that or another registered scheme will be subject to an LTA charge at an effective tax rate of 55%.

What are the transitional rules?

Individuals who had accumulated pension benefits in excess of the LTA of £1.5 million at A-Day, or those who anticipate their pension benefits will exceed the prevailing LTA when benefits are drawn would suffer from the change in rules. As a result, transitional provisions were introduced which allow individuals to protect their pension rights/benefits from the potential LTA charge.

Such protection must be applied for and registered with HM Revenue and Customs (HMRC) by 5 April 2009, or will be lost. Applications require a valuation of the fund(s) to be prepared before the application is made, meaning action on obtaining such valuations must be taken now.

Even if the pension benefits in question arise through an employer or occupational scheme, it is still the responsibility of the individual to apply for protection, not that of the scheme owner or manager.

What protection may be applied for?

There are two types of protection that may be applied for, primary protection and enhanced protection.

Primary protection is only available to individuals whose fund/rights are valued in excess of £1.5 million at 5 April 2006. This protection has the effect of increasing the LTA by the same proportion as the fund value exceeded £1.5 million at that date. For example, if the fund value at A-Day was £3 million, this is the personal LTA starting point for that individual, and his rate will increase over time at the same rate of increase as the standard rate, which is broadly in line with the retail prices index.

It is important to note that primary protection may not, therefore, offer full protection from the LTA charge- should the fund/rights value grow at a faster rate than the LTA increases, any excess will still be charged under the LTA provisions.

Enhanced protection is available irrespective of the fund value at 5 April 2006 and can offer complete protection from the 55% LTA charge. This type of protection can be claimed where future pension benefits are anticipated to exceed the prevailing rate of LTA when they are crystallised.

An important condition attaching to this type of protection is that an individual may not make any further contributions to a defined contribution scheme after 5 April 2006, and may only make additions to a final salary scheme within strict limits.

Both types of protection will also protect the availability of an increased tax-free lump sum, which, under the new regime would be limited to 25% of the prevailing LTA.

Both primary and enhanced protection can be registered for independently, and it is possible to surrender enhanced protection voluntarily at a future date, provided a valid application has been made by 5 April 2009. This gives increased flexibility allowing individuals to wait-and-see which method of protection provides a better result when benefits are drawn. However, once applied for, primary protection cannot be surrendered voluntarily.

HMRC has now published its own guidance on the process, together with the prescribed APSS200 form for claiming protection.

Neil Messenger, Head of Financial Planning at Grant Thornton says: "The appropriate protection must be registered by 5 April 2009 to avoid potentially significant tax consequences. Time delays can arise in obtaining the valuation of existing pension rights from pension providers and therefore for those who have not yet registered for protection it is important to addressed this issue now. "

Please contact us if you would like further advice on any of the above.