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Transitional protection

When the lifetime allowance (LTA) was introduced at A-Day (6 April 2006), there were two types of protection brought in at the same time. The aim was to give individuals who were close to, or already over the initial £1.5M LTA a measure of protection from the LTA tax charge on any benefits that have yet to come into payment.

• Primary protection - This was only available for those who had pension benefits greater than £1.5M as at 5 April 2006. This included the value of any pensions that were already in payment at that date.
  
  The protection was given as an enhancement to the standard LTA based on how much the individual’s benefits exceeded £1.5M.
• Enhanced protection - Anyone could apply for this protection regardless of the value of their pension savings at A-Day. As long as the protection isn't lost or revoked, there will never be a LTA tax charge.
  
  One of the conditions of this protection was that all ‘relevant benefit accrual’ ceased before A-Day.
  
  For defined contribution (DC) schemes - also referred to as money purchase schemes - this meant no further contributions (although there are exceptions for contributions to some life assurance contracts).
   
  For defined benefit (DB) schemes, contributions and membership didn’t have to stop to qualify for enhanced protection, but there is a limit on the amount of benefits that the scheme can pay out (or transfer to another pension scheme) without losing enhanced protection. This is known as the ‘appropriate limit’  - more on this later.

The possible lifetime allowance tests on death

Every time untouched benefits from a pension scheme are brought into payment, this is a benefit crystallisation event (BCE) and the benefits aretested against the LTA. Any protection the member has at the time of a BCE can prevent or reduce a LTA tax charge.

On the member’s death, the payment of certain death benefits are also tested against the deceased’s LTA and their protection can still help in these instances.

The following benefits are tested against the LTA on the death of the original member before age 75:

DB schemes

• Lump sums - known as defined benefit lump sum death benefits. These are paid by the scheme following the death of the member. Typically these are death-in-service benefits, usually based on a multiple of salary.

DC schemes

• Lump sums from uncrystallised funds (including lump sums from life cover)
• Designating uncrystallised funds for survivor’s income drawdown
• Purchasing a survivor’s lifetime annuity from uncrystallised funds

Two year rule

All of these types of death benefit are only BCEs if they are paid (or designated/purchased) within two years of the date the pension scheme administrator first knew, or could reasonably have been expected to know, of the member’s death (whichever is earlier). If there isn’t enough of the deceased’s LTA available, the recipients will have to pay a LTA charge, but there would be no other income tax liability.

If they’re paid outside of the two year period, they’re no longer tested against the LTA, but they will be subject to income tax at the recipient’s marginal rate (or a flat rate of 45% if not being paid to an individual - for example, if paid to a trust).

Death benefits not tested against the LTA

A dependant’s pension paid from a DB scheme is typically classed as a 'scheme pension' and not tested against the LTA. DC schemes can also provide scheme pensions for dependants, but this is uncommon. A dependant’s scheme pension is subject to income tax at the recipient’s marginal rate. 

Primary protection and death benefits

The increase to the LTA given by primary protection is based on the benefits the individual had accrued as at 5 April 2006, including pensions already in payment. However, it was only retirement benefits that were taken into account - the rights to life assurance cover or other lump sum benefits that only had a value on death could not be included.

But, a recalculation of primary protection to cover lump sum rights is possible in some circumstances.

Pension death benefits

On death, the payment of a survivor’s pension from a DC arrangement, whether paid as income drawdown or as a lifetime annuity income, is a BCE.  

Dependants’ pensions from DB schemes as well as dependants’ scheme pensions under a DC arrangement are not BCEs.

A recalculation of the individual’s primary protected LTA isn’t possible when death benefits (survivor’s pension or lump sum) are only paid from a DC arrangement. This is because the DC arrangement was taken into account at A-Day when calculating the primary protection enhancement factor. Unfortunately this doesn’t rule out a LTA tax charge on death, as the fund growth and any additional contributions are likely to mean that the fund value on death exceeds the individual’s primary protected LTA.

Lump sum death benefits

Initially, BCEs from lump sum death benefits are tested against the deceased’s remaining LTA increased by the original primary protection factor. However, because some types of lump sum death benefit wouldn’t have been included in the original primary protection factor, it is possible to recalculate in some circumstances.

There are two types of lump sum death benefit - a defined benefits lump sum death benefit (for example, a 4 x salary death-in-service lump sum) and an uncrystallised funds lump sum death benefit from a DC scheme (which could be the return of fund from a scheme, or insured life cover).

Benefits that are only payable on death, such as the death-in-service or life cover lump sum, wouldn’t have been included when working out the primary protection factor. If this type of death benefit is payable, it may be possible for the recipient of the lump sum death benefits to ask HMRC to recalculate the deceased's enhancement factor, based on the lump sum death benefit cover in force on 5 April 2006. This can give a bigger personal LTA on death if, as at 5 April 2006, the lump sum death benefits were worth more than the individual's retirement benefits.

The recalculation is based on the amount of lump sum death benefits only that could have been paid had the deceased died back on 5 April 2006. For it to apply, this total would need to:

1. be greater than £1.5M, and
2. be greater than the retirement benefits used to calculate the original primary protection amount

Exclusions when calculating lump sum death benefits as at 5 April 2006

The following are excluded:

• Any amount above the maximum HMRC limits for death benefits under the rules in force on 5 April 2006
• The dependants' pension proportion amount (if any). This is broadly any proportion of the lump sum paid on death that is used to provide dependants' pensions. However, pensions payable to non-dependants (nominees and successors) don’t affect the calculation

• Any lump sum death benefit payable under a life assurance policy on 5 April 2006 by any scheme (other than an occupational pension scheme with at least 20 members on 5 April 2006) where:
  
  
  • the policy doesn't pay out a lump sum after 5 April 2006, or
  • the terms of the policy are changed significantly in the period between 5 April 2006 and the date of death.
• Any lump sum death benefit payable from an occupational pension scheme on 5 April 2006 where:
  
  
  • the individual wasn't continuously employed in the period from 5 April 2006 to the date of death by either the same employer as they had been on 5 April 2006 or by someone connected with that employer, or
  • the individual was already entitled to benefits under the occupational pension scheme before their death.

These items are also excluded when recalculating the appropriate limit under enhanced protection.

Enhanced protection and death benefits

The way enhanced protection covers death benefits differs between DC and DB schemes.

Defined contribution (DC) schemes

As long as enhanced protection is still in force at the date of death then benefits from DC schemes, whether paid as lump sums or in the form of a pension, are fully covered.

Enhanced protection remains in force as long as no contributions are paid to a DC scheme after 5 April 2006. However, there are special rules concerning ongoing life cover under DC schemes (typically as term assurance under personal pensions and retirement annuity contracts).

Maintaining payments to life assurance contracts

Enhanced protection will not be broken by continuing contributions if:

• they're used to fund life cover under a contract of insurance,
• the insurance contract was made before 6 April 2006*,
• there's no right to surrender any rights under the policy,
• there's no payment under the policy except on the individual's death, and
• the policy isn't varied significantly. Examples of significant variation are:
  
  
  • extending the contract term
  • an increase in the contributions or amount of death benefit (although if the terms of the policy provide for automatic increases, that wouldn't be a variation)
  • the addition or removal of an extra benefit
  • taking a contribution holiday

* A new policy can be treated as a pre 6 April 2006 contract if it’s surrendered and replaced by a new one to comply with:

• the Employment Equality (Age) Regulations, or
• Section 255 of the Pensions Act 2004 (which prohibits 'life assurance only' categories under occupational pension schemes where there's no intention to ever provide pension benefits for the members in the life assurance only category).

Defined benefit (DB) schemes

Pension death benefits from DB schemes can only be paid in the form of scheme pensions to dependants and are not tested against the LTA.

However, defined benefit lump sum death benefits are tested against the deceased’s LTA and for enhanced protection, this means the amount needs to be within the appropriate limit otherwise protection will be lost. In that event, the lump sum would be then tested against any remaining amount of the standard LTA (or potentially any personal LTA granted through primary or individual protection, if either applies).

The appropriate limit

The appropriate limit is usually calculated based on the value of the individual's retirement benefits under the DB scheme on 5 April 2006. These are then revalued up to the point of retirement, transfer, or death by the higher of RPI or 5% per annum, or if the member remains in service with the employer, they can also use their increased pensionable salary (subject to certain rules - see our guide 'DB transfers and the appropriate limit' for full details).

But on death, special rules allow the recipient of any lump sum death benefit to ask HMRC to recalculate the appropriate limit based on the value of the lump sum death benefits that would have been payable on 5 April 2006, if this is greater than the normal appropriate limit.

Exclusions when calculating lump sum death benefits as at 5 April 2006

Here we use the same exclusions that apply to primary protection, which are:

• Any amount above the maximum HMRC limits for death benefits under the rules in force on 5 April 2006
• The dependants' pension proportion amount (if any). This is broadly any proportion of the lump sum paid on death that is used to provide dependants' pensions. However, pensions payable to non-dependants (nominees and successors) don’t affect the calculation
• Any lump sum death benefit payable under a life assurance policy on 5 April 2006 by any scheme (other than an occupational pension scheme with at least 20 members on 5 April 2006) where:
  
  
  • the policy doesn't pay out a lump sum after 5 April 2006, or
  • the terms of the policy are changed significantly in the period between 5 April 2006 and the date of death
• Any lump sum death benefit payable from an occupational pension scheme on 5 April 2006 where:
  
  
  • the individual wasn't continuously employed in the period from 5 April 2006 to the date of death by either the same employer as they had been on 5 April 2006 or by someone connected with that employer, or
  • the individual was already entitled to benefits under the occupational pension scheme before their death

Maintaining death-in-service benefits under enhanced protection

To qualify for enhanced protection, contributions to DB schemes didn’t have to cease as maintaining the protection is based on the appropriate limit. This enables ongoing membership of a death-in-service arrangement to continue.

However, enhanced protection is lost if the individual becomes a member of a new arrangement other than in the following permitted circumstances:

• to accept a permitted transfer of pension rights
• to comply with the Employment Equality (Age) Regulations, or
• to comply with Section 255 of the Pensions Act 2004 (which prohibits 'life assurance only' categories under occupational pension schemes where there's no intention to ever provide pension benefits for the members in the life assurance only category)

In relation to death-in-service benefits, if an individual becomes a member of a new arrangement after 5 April 2006 that doesn’t meet the above criteria - for example, on joining a new employer - then they would lose their enhanced protection.

Applying for a recalculation of protection

The recipient of a lump sum death benefit can ask HMRC to recalculate the primary protection factor or the appropriate limit for enhanced protection if that will give a greater amount of protection.

The notification must be made to HMRC within five years following 31 January after the tax year in which a defined benefits or uncrystallised funds lump sum death benefit was paid.

There isn't a specific HMRC form to be completed - a letter signed by the applicant containing all of the following information is needed:

• the name and address of the person making the notification
• the name of the deceased protected member
• the name of the pension scheme under which entitlement to payment of the defined benefits lump sum death benefit or uncrystallised funds lump sum death benefit arose
• the name and address of the scheme administrator making the payment
• the amount of the defined benefits lump sum death benefit or uncrystallised funds lump sum death benefit received by the person making the notification
• the date on which the payment was made