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Benefits of enhanced protection

Enhanced protection offers full protection against a lifetime allowance (LTA) tax charge. This is on the condition that all contributions or other relevant benefit accrual ceased before A-Day (6 April 2006).

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.

It was introduced to protect individuals whose benefits were likely to exceed the LTA. Individuals had to apply for enhanced protection before 6 April 2009.

Losing enhanced protection

Enhanced protection is normally lost if:

• 'relevant benefit accrual' has occurred
• certain types of pension transfer are received/made or
• you become a member of a new pension arrangement (unless it's a transfer of your existing rights)

It's the member's responsibility to tell HMRC if enhanced protection is lost. Failure to do this within 90 days can result in a financial penalty.

If enhanced protection is lost, individuals will revert back to the standard LTA unless they have another type of protection to fall back on - for example, primary protection which could have been applied for at the same time as enhanced protection, or individual protection which could have been applied for later.

Relevant benefit accrual

A condition of maintaining enhanced protection is that there's no 'benefit accrual' after 5 April 2006.

For defined contribution schemes (DC) this normally means no contribution paid after 5 April 2006.

The only exception being contributions to life cover arrangements set up before A-Day. In these circumstances, as long as the policy has not been significantly altered since A Day - for example, there's been no change to the policy term, contribution levels or cover - protection can be maintained.

For defined benefit schemes (DB) the test is more complicated and is done when:

• the member crystallises benefits under an arrangement
• a permitted transfer is made to a DC scheme or
• a payment of lump sum death benefits is made

Broadly benefit accrual has taken place if the value of benefits when taken or transferred (the 'relevant event date') is greater than the 'appropriate limit'.

The 'appropriate limit' is the value of the member's DB benefits at 5 April 2006. This can then be increased up to the relevant event date by the greater of;

• 5% a year compound (or RPI if higher) or
• an earnings based recalculation value

The earnings recalculation value allows the A-Day benefits to be revalued using earnings after 6 April 2006.

If the appropriate limit is exceeded, enhanced protection will be lost.

More detail on appropriate limit calculations can be found in our guide ‘DB transfers and the appropriate limit’.

Enhanced protection and transfers

Individuals with enhanced protection will normally be protected if they transfer their benefits to another scheme. But, the move must be a permitted transfer - which has to meet certain criteria.

Transfers that don't affect enhanced protection

• DC to DC
• DB or cash balance to DC, as long as the transfer payment:
  
  
  • is the actuarial value of the pension rights being transferred - for example, it's not an enhanced transfer
  • the amount transferred is within the appropriate limit

Additionally, the receiving scheme must be either a registered pension scheme or a QROPS.

Transfers that would result in a loss of enhanced protection

• DC to DB or cash balance
• Any transfer to an unregistered pension scheme or an overseas scheme which is not a QROPS
• DB to DC if the transfer payment is not the actuarial value of the pension rights being transferred - for example, where an enhanced transfer is given
• DB to DC if the transfer payment is above the appropriate limit
• DB or cash balance to DB or cash balance - unless the transferring scheme is being wound up and the receiving scheme is for the same employment, or the benefits are being transferred as part of a relevant business transfer
• A transfer as a result of a pension sharing order, where a new arrangement is set up to receive pension credit rights directly from the original member's pension.
  
  However, if the pension credit is paid into an existing arrangement, enhanced protection is not affected. Thereafter, the pension credit rights can be transferred to a new arrangement, normally without affecting enhanced protection.

A transfer from a scheme that's not a UK registered pension scheme doesn't, in itself, result in the loss of enhanced protection. But if a new arrangement is set up to accept the transfer, then enhanced protection is lost.

Partial transfers from defined benefit schemes

Where the value of a 'permitted transfer' exceeds the appropriate limit, enhanced protection will be lost. But to avoid this, a partial transfer could be considered to ensure protection is maintained.

Not all schemes currently offer this but, where it's available, individuals can transfer some of their pension benefits up to the level of the appropriate limit without losing their enhanced protection.

After the partial transfer has been made, there is still the potential to lose enhanced protection, so care needs to be exercised when taking benefits. This generally means crystallising all the benefits in the DC Scheme before triggering a further appropriate limit test on the remaining DB scheme. This will ensure that the DC scheme can be taken under enhanced protection, even if the testing of the remaining DB scheme exceeds the appropriate limit.

A further test against the appropriate limit would occur:

• when remaining benefits are taken
• on completion of a further partial, or full, transfer out
• on the payment of a lump sum death benefit, or
• when your client reaches age 75

The test will compare the value of benefits remaining within the DB scheme together with the amount previously transferred out against the appropriate limit when the event occurs.

For more detail, please see our guide ‘DB transfers and the appropriate limit’.

Divorce

Enhanced protection is not affected if someone becomes subject to a pension debit as a result of pension sharing order. But they wouldn't be able to rebuild their pension benefits without losing the protection.

Care is needed when giving advice on securing pension credit rights for someone with enhanced protection:

• If a new arrangement is set up to accept the pension credit directly from the original member's pension, enhanced protection is lost
• But if it’s paid into an existing pension arrangement, enhanced protection is not affected. After that, the pension credit rights can normally be transferred to a new arrangement without affecting the protection

Taking benefits

Before taking benefits the pension provider or trustees should be given a copy of the enhanced protection certificate. Without this, benefits would be tested against the standard LTA.

The level of tax free cash available depend on whether or not tax free cash rights were registered under enhanced protection.

Registered tax free cash

If someone applying for enhanced protection had rights to tax free cash in excess of £375,000 at A-Day, this could also be protected. The enhanced protection certificate will confirm the amount that can be taken as a percentage of the uncrystallised fund. The percentage itself may be greater or less than 25%.

The registered tax free cash percentage will apply each time uncrystallised benefits are taken after A-Day, and is not lost if tax free cash is taken at different times.

No registered tax free cash

If tax free cash rights were below £375,000 at A-Day, they won't be mentioned on the enhanced protection certificate, but will be the lower of:

• 25% of the crystallised value being taken
• 25% of £1.5M* less any previous crystallisation amounts revalued

* unless exceeded by standard LTA

The revaluation of previous tax free cash taken is dependent on when the previous crystallisations happened - but the basic calculation formula is:

Amount crystallised x (CSLA/PSLA)

As the LTA hasn’t exceeded £1.5M since the 2011/12 tax year, this means that there’s no revaluation of benefits crystallised since 6 April 2012. This is because the value of benefits crystallised is multiplied by £1.5M/£1.5M.

Scheme-specific tax free cash

If someone had lump sum rights below £375,000 and were unable to register their tax free cash, they may still be able to get more than 25% tax free cash from a particular pension scheme. This would be possible if the individual was entitled to more than 25% tax free cash from that scheme at A-Day.

To benefit from 'scheme specific' tax free cash, the whole fund must be crystallised at the same time, although it's possible for everything in excess of tax free cash to be left in a flexi-access drawdown account.

Death benefits

The impact of paying pension death benefits for individuals with enhanced protection depends on the type of scheme they're paid from.

Defined contribution schemes

Enhanced protection will fully cover the death benefits paid from a DC scheme. This means regardless of value, the following types of death benefit can be paid out with suffering an LTA tax charge:

• lump sum
• inherited drawdown for a dependant/ other beneficiary
• lifetime annuity for a dependant/other beneficiary
• insured life cover lump sum (see section on life assurance policies)
• dependant's scheme pension

Defined benefit scheme - dependant's pension or lump sum

For a DB scheme, the type of death benefits paid out will determine the position.

• Dependant's scheme pension: Death benefits paid as a dependant's scheme pension are not tested against the appropriate limit and won't invalidate enhanced protection or incur an LTA tax charge.
• Defined benefit lump sum: To maintain enhanced protection, lump sum death benefits must be within the appropriate limit. The appropriate limit can be calculated using the same calculation as described above, or in some circumstances, be recalculated using the value of lump sum death benefits at A-Day, if that produces a higher figure.

Contributions for life assurance policies

Payments to defined contribution schemes had to stop after A-Day to retain enhanced protection.

But, there are certain exceptions which allow contributions for life cover to continue, without invalidating enhanced protection. To qualify for this exemption:

• payments into the policy must only be used for life cover
• the insurance contract must have been in place on A-Day (i.e. started before 6 April 2006). Post A-Day policies can replace original contracts, but only if the original was surrendered to comply with either:
  
  
  1. Employment Equality (Age) Regulations, or
  2. Section 255 of Pensions Act 2004 - which stops occupational pension schemes from providing life cover only benefits
• there are no surrender rights under the policy
• the policy's only pay-out option is on the member's death
• the terms of the policy have not been 'significantly' changed

Enhanced protection - applications

Individuals had to apply for enhanced protection before 6 April 2009. Those with enhanced protection will hold a certificate confirming the details plus any registered tax free cash entitlement (if applicable). Each certificate has a unique reference number.

Updating or revising an existing Certificate

While no new applications can be submitted for enhanced protection, HMRC still allow existing certificates to be updated or revised.

One of the more common corrections is in relation to tax free cash entitlement - usually as a result of incorrect information being provided on the original application or the discovery of a forgotten pension.

If you need to amend or revise a client's existing enhanced protection certificate, you should complete the APSS200 form with the new details and submit it online to HMRC.