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Pension sharing - LTA implications

Pension sharing as part of a divorce settlement can affect either party’s lifetime allowance (LTA). Any LTA impact depends on if the client is giving up pension rights (a pension debit) or receiving them (a pension credit) and whether they have transitional protection.

Pension debits - giving up pension rights as a result of pension sharing

A pension debit doesn't usually affect the client's LTA, but it can for some with transitional protection (see below).

For those without transitional protection looking to make further pension funding after a pension debit, the available LTA has been something that also needed to be considered.

However, the Spring Budget 2023 announced that there will be no LTA tax charge on benefits taken in excess of the LTA in tax year 2023/24 – although testing against the LTA will continue as normal – and the intention is that the LTA will be abolished from 6 April 2024.

• There's no adjustment to the amount of LTA that's already been used up by funds that were crystallised before the pension debit
• However, generally, further pension funding can be made to "replace" uncrystallised funds that were transferred to the former spouse, as the transferred funds will now count towards the ex-spouse's LTA
• Although there will no longer be LTA charges, there is still a limit on tax free cash rights

Pension credits - receiving pension rights as a result of pension sharing

The extra benefits an individual receives in respect of a pension credit will count towards the recipient's LTA

However, in some circumstances, the individual can claim an enhancement to their LTA – called a 'pension credit factor'. The treatment of the pension credit for LTA purposes depends on whether the pension credit rights were acquired:

• before 6 April 2006, or
• on or after 6 April 2006 (and, if so, whether or not the member was already receiving the pension).

The situation can also be different if the member has transitional protection (see below).

It's also worth noting that where a pension credit factor can be claimed and does give extra LTA, it doesn't increase the amount of tax free cash available - this is still based on 25% of the standard LTA (or 25% of any protected LTA under fixed or individual protection).

Pension credit acquired after 5 April 2006

Someone who gets a pension credit as a result of a pension sharing order made after 5 April 2006 can only claim an increase to their LTA if:

• the original member's pension came into payment after 5 April 2006 and
  
• was in payment when the pension sharing order was made.

The increase is called the pension credit factor. It's calculated by dividing the value of pension credit by the standard LTA in force when the credit is awarded.

If the individual has any of the fixed protections or individual protections in place at that time, they would substitute their own protected LTA for the standard LTA in the calculation.

The factor is rounded up to two decimal places.

To claim the increase, a completed form APSS201 must be sent to HMRC no later than five years after the 31 January following the tax year when the pension sharing order took effect.

The way the pension credit factor is then applied depends when the pension credit is awarded:

• Pension credit awarded between 6 April 2006 and 5 April 2012 - the increase to the person's LTA is calculated by multiplying an underpinned LTA of £1.8M (or the standard LTA if higher) by their enhancement factor
• Pension credit is awarded between 6 April 2012 and 5 April 2014 - the increase to the person's LTA is calculated by multiplying an underpinned LTA of £1.5M (or the standard LTA if higher) by their enhancement factor
• Pension credit is awarded between 6 April 2014 and 5 April 2016 - the increase to the person's LTA is calculated by multiplying an underpinned LTA of £1.25M (or the standard LTA if higher) by their enhancement factor
• Pension credit is awarded after 5 April 2016 - the increase is calculated by multiplying the standard LTA in force when the benefit crystallisation event takes place by their enhancement factor

In all cases, this extra allowance is added to the standard LTA (or, if higher, the protected LTA under either fixed or individual protection) to calculate the individual's LTA.

Pension credit acquired before 6 April 2006

It was possible to claim an increase to the LTA based on a pension sharing order made before 6 April 2006, but the claim had to be made before 6 April 2009. Those who had registered for primary protection were unable to claim further protection.

This increase is called the pre-commencement pension credit factor. It was calculated by dividing the value of the pension credit (indexed by RPI to 5 April 2006) by the standard LTA for the tax year 2006/07 (£1.5M).

The increase is applied to the standard LTA in force when benefits are crystallised.

Disqualifying pension credits

Any part of a pension credit that came from a pension already in payment is called a disqualifying pension credit. As mentioned above, some recipients are able to claim an enhancement to their LTA. However, no tax free cash can be paid from disqualifying pension credits.

This means that care must be taken around the order in which benefits are crystallised for individuals who are likely to exceed the LTA. Taking funds which represent a disqualifying pension credit before taking other pension funds could restrict the amount of tax free cash available, because it will use up some (or possibly all) of the individual's available LTA.

Pension sharing and enhanced protection

Receiving a pension credit

The effect on enhanced protection of receiving a pension credit on divorce depends on when and how the rights are secured.

• If the pension credit is paid from the original member's pension into an existing pension arrangement of the recipient, their enhanced protection is not affected. Thereafter, the pension credit rights can be transferred to a new arrangement, normally without affecting enhanced protection.
• If a new arrangement was set up to accept the pension credit directly from the original member's pension before 6 April 2023, the recipient will have lost their enhanced protection.
• From 6 April 2023, a new arrangement can be set up to receive the pension credit without invalidating enhanced protection – except in the very unlikely situation that the individual successfully registered enhanced protection after 15 March 2023.

This meant that, in the past, advisers had to take extra care when giving advice on securing pension credit rights for clients with enhanced protection - but now it's not normally an issue.

In certain circumstances it's possible to claim an LTA enhancement factor when receiving a pension credit. Those with enhanced protection generally wouldn't need to apply for this because, as long as enhanced protection is maintained, their benefits aren't subject to the LTA charge. And, of course, the enhancement doesn't give any higher entitlement to tax free cash. But they may still wish to apply for the enhancement, just in case they lose their enhanced protection.

Being subject to a pension debit

Enhanced protection is not affected by a pension debit. But before 6 April 2023, the ability to rebuild the rights that were lost will depended on the type of protection and the type of pension scheme the member had.

• Defined benefit (or cash balance) pension scheme - it was possible to build up their rights provided that, when they crystallise or transfer their benefits, they don't exceed the 'appropriate limit'
• Money purchase pension scheme - making contributions to rebuild the pension resulted in the loss of enhanced protection

Since 6 April 2023, individuals with enhanced protection have been able to recommence pension funding (or continue accruing defined benefit pensions) without fear of losing their protection – except in the very unlikely situation that the individual successfully registered enhanced protection after 15 March 2023.

Pension sharing and primary protection

Receiving a pension credit

The effect on primary protection of receiving a pension credit on divorce depends on where the pension credit comes from.

If a pension credit is generated from an uncrystallised pension, or a pension that was already in payment before 6 April 2006, then there's no change to the amount of primary protection the recipient has. This means it could be possible that the increased benefits will exceed the available protection which, before 6 April 2023, could have resulted in an eventual LTA charge.

However, it's possible to claim an LTA increase (known as a pension credit factor - a type of LTA enhancement factor) to existing primary protection if the pension credit:

• comes from a pension already in payment to the original member and
• the entitlement to that pension arose after 5 April 2006.

This reflects that these benefits will already have been tested against the original member's LTA.

If a pension credit was received before 6 April 2006, the value of the pension credit rights would have been included when calculating the person's LTA enhancement factor under primary protection.

Being subject to a pension debit

If someone has primary protection and their pension benefits are reduced as a result of a pension debit, their LTA enhancement factor has to be recalculated. HMRC need to be told of the sharing order and will issue a new primary protection certificate based on the revised calculation.

This is done by deducting the value of the pension debit rights given up from the original benefit value as at 5 April 2006 and then recalculating the enhancement factor using this new, lower, benefit value. Any benefits crystallised after the pension sharing order has taken effect are tested against the member's available personal LTA, based on their reduced LTA enhancement factor.

Primary protection will be lost if the pension debit reduces the value of the member's pension rights as at 5 April 2006 to a figure that's under £1.5M - this is the only way someone can lose primary protection.

Pension sharing and fixed protection

Receiving a pension credit

There are two areas where receiving a pension credit on divorce can create issues for those who have fixed protection (2012, 2014 or 2016).  But since 6 April 2023, these only affect those who registered their fixed protection after 15 March 2023.

The effect on fixed protection of receiving a pension credit on divorce depends on how the rights are secured.

• If the pension credit is paid from the original member's pension into an existing pension arrangement of the recipient, their fixed protection is not affected. Thereafter, the pension credit rights can be transferred to a new arrangement, normally without affecting fixed protection
• But, if a new arrangement is set up to accept the pension credit directly from the original member's pension, the recipient will lose their fixed protection.

So advisers have to take extra care when giving advice on securing pension credit rights for clients with fixed protection as some could potentially lose it.

It's possible to claim an LTA increase (known as a pension credit factor) to existing fixed protection if the pension credit:

• comes from a pension already in payment to the original member and
• the entitlement to that pension arose after 5 April 2006.

This allows the recipient to claim an LTA enhancement factor that will give them an increase on top of their protected LTA of £1.8M, £1.5M or £1.25M.

But if a pension credit is generated from an uncrystallised pension, or a pension that was already in payment before 6 April 2006, then there's no change to the amount of fixed protection the recipient has. This means that it could be possible that the increased benefits will exceed the available protection which, before tax year 2023/24, would have resulted in an eventual LTA charge.

Being subject to a pension debit

Fixed protection is not affected when pension benefits are reduced as a result of a pension debit under a divorce settlement, but the ability to rebuild the rights that have been lost is limited for some individuals -  different rules apply depending on the type of schemes concerned and, since 6 April 2023, when protection was registered.

• Defined benefit (or cash balance) pension scheme - the ability to rebuild rights can be limited as the increase in benefits each tax year can't be more than the relevant percentage. This would generally mean that an active member would be restricted to an increase of no more than CPI (based on the figure from the September before the tax year concerned). Any increase during the tax year greater than this would invalidate fixed protection.
  
  However, since 6 April 2023, this only applies to those who registered their fixed protection after 15 March 2023.
• Money purchase pension scheme - making contributions to rebuild the pension will result in fixed protection being lost.
  
  However, since 6 April 2023, this only applies to those who registered their fixed protection after 15 March 2023.

Individuals who registered fixed protection by 15 March 2023 have, since 6 April 2023, been able to recommence pension funding or accrue defined benefit pensions without fear of losing their protection.

Pension sharing and individual protection

Receiving a pension credit

The effect on primary protection depends on where the pension credit comes from.

The effect on individual protection (2014 or 2016) of receiving a pension credit on divorce depends on where the pension credit comes from.

If a pension credit is generated from an uncrystallised pension, or a pension that was already in payment before 6 April 2006, then there's no change to the amount of individual protection the recipient has. This means it could be possible that the increased benefits will exceed the available protection which, before 6 April 2023, could have resulted in an eventual LTA tax charge.

But it's possible to claim an LTA increase (known as a pension credit factor) to existing individual protection if the pension credit:

• comes from a pension already in payment to the original member and
  
• the entitlement to that pension arose after 5 April 2006.

This reflects that these benefits will already have been tested against the original member's LTA. The enhancement factor will give the recipient of the credit an increase on top of their protected LTA. However, it doesn't give any higher entitlement to tax free cash.

Being subject to a pension debit

If someone with individual protection has their pension benefits reduced as a result of a pension debit, their LTA enhancement factor has to be recalculated. The original valuation for individual protection purposes will be reduced by the amount of the pension debit - but the value of the debit can sometimes be reduced:

• IP2014 - if the transfer date of the debit is after 5 April 2015, the value of the pension debit is reduced by 5% for each complete tax year since 2013/14
• IP2016 - if the transfer date of the debit is after 5 April 2017, the value of the pension debit is reduced by 5% for each complete tax year since 2015/16

If the recalculation takes the individual protection value below £1.25M (IP2014) or £1M (IP2016), protection is lost from that point onwards.

Of course, if someone loses IP2014, they may still be able to apply for IP2016.

An individual subject to a pension sharing order must inform HMRC within 60 days. HMRC will either adjust the level of protection, or revoke it altogether if the revised valuation is £1.25M (IP2014)/£1M (IP2016) or under.