Techzone

Background to enhanced protection

Enhanced protection was introduced to offer full protection against lifetime allowance (LTA) tax charges when the LTA was introduced on 6 April 2006 (known as ‘A-Day’). This was on the condition that all contributions or other relevant benefit accrual ceased from that point.

Anyone could apply for this protection, regardless of the value of their pension savings at A-Day, but it was aimed at individuals whose benefits were likely to exceed the LTA. As long as the protection wasn’t lost or revoked, there would never be an LTA tax charge.

It was also possible for some individuals to register their tax-free cash rights for protection.

Individuals normally had to apply for enhanced protection before 6 April 2009.

The Spring Budget 2023 announced that the LTA would be abolished from 6 April 2024 and that LTA tax charges would not apply for tax year 2023/24. It also announced the removal of some restrictions for those with enhanced protection which mean that it can rarely now be lost.

However, the removal of the LTA does not mean that enhanced protection is no longer valid. New allowances have replaced the LTA and enhanced protection is still relevant for the purposes of calculating the individual’s ‘lump sum allowance’ (LSA) and ‘lump sum and death benefit allowance’ (LSDBA). These allowances cap the amount of tax-free lump sums that can be paid during the member’s lifetime and on death.

Taking benefits

Since the abolition of the LTA, when an individual is taking benefits it’s just the level of tax-free cash available that needs to be calculated and tested against the LSA. There’s no testing of benefits paid as a pension.

Before taking benefits, the pension provider or trustees should be given a copy of the enhanced protection certificate. Without this, the provider would test the member’s tax-free cash against the standard LSA.

For individuals with enhanced protection, the level of tax-free cash available depends on whether or not tax-free cash rights were also registered under enhanced protection.

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.

The maximum tax-free cash available when crystallising benefits will normally be the lower of:

• 25% of the crystallised value being taken
• £375,000 less*
  
  
  • 25% of the LTA used up by any benefits taken before 6 April 2024 and
  • any tax-free cash taken on or after 6 April 2024

* If any benefits were taken before A-Day and were not tested against the LTA - i.e. because there were no benefit crystallisation events before 6 April 2024 - then 25% of the value of these benefits also needs to be deducted.

Alternatively, the new rules provide that if clients can evidence how much tax-free cash they’ve actually received in the past, they can apply for a ‘transitional tax-free amount certificate’ (TTFAC) confirming the aggregate amount to be deducted from their LSA. For some clients this may increase the remaining LSA and, therefore, more tax-free cash than under the standard calculation.

Clients who potentially could receive more tax-free cash post-April by obtaining a TTFAC include, for example, those who:

• took low or no tax-free cash because their scheme had generous guaranteed annuity rates
• were in DB schemes but didn’t commute pension for their full tax-free cash entitlement
• took benefits during the four tax years when the LTA was lower than £1.0731M (i.e. 2016/17 to 2019/20)

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 and therefore have ‘scheme-specific tax-free cash protection.

For the purpose of LSA testing, only 25% of the value of benefits crystallised will count towards the individual’s LSA - the excess tax-free cash above that can be ignored.

Registered tax-free cash

If someone applied for enhanced protection and had rights to tax-free cash in excess of £375,000 at A-Day, this could also be protected. The individual’s enhanced protection certificate confirms 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 applies each time uncrystallised benefits are taken.

However, the available tax-free cash under an arrangement is now capped at the amount that could have been paid on 5 April 2023, less the total of any tax-free already taken under the arrangement after that date.

New contributions can be made after 5 April 2023 without losing this protection, but they will not generate any new tax-free cash entitlement.

Individuals with registered tax-free cash rights under enhanced protection cannot apply for a TTFAC.

Death benefits

On death before age 75, certain death benefits have to be tested against the allowance in force at the time. Before 6 April 2024 this was the LTA and, from that date, it’s the LSDBA.

LTA - before 6 April 2024

The way enhanced protection covered death benefits differed between DC and DB schemes.

• DC schemes - As long as enhanced protection was 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, were fully protected from LTA tax charges.
  
  
• DB schemes - Scheme pensions paid to dependants were not tested against the LTA but lump sum death benefits were. And for enhanced protection, this meant the amount needed to be within the appropriate limit otherwise protection was lost and LTA tax charges could apply.
  
  The appropriate limit was usually calculated based on the value of the individual's retirement benefits under the DB scheme on 5 April 2006 and these were then revalued up to the point of retirement, transfer, or death. But on death, special rules allowed 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 was greater than the normal appropriate limit.
  
  The Spring Budget 2023 announced the intention to abolish the LTA from 6 April 2024, that LTA tax charges would not apply for tax year 2023/24 and that enhanced  protection could no longer be lost (with the exception mentioned earlier). This meant that the appropriate limit test was no longer required. 

LSDBA - from 6 April 2024

For those with enhanced protection, their LSDBA is set as the value of their uncrystallised funds on 5 April 2024. The transitional rules to calculate how much needs to be deducted for LSDBA purposes in respect of benefits taken before 6 April 2024 do not apply to those with enhanced protection.

Any death benefits paid from pensions crystallised before 6 April 2024 are not tested against the LSDBA. 

The LSDBA is a combined allowance for both lifetime tax-free lump sums and tax-free lump sum death benefits. So, the amount available for lump sum death benefits will be reduced by any tax-free cash amounts the member has taken, including any serious ill-health lump sums.

Lump sum death benefits in excess of the available LSDBA are subject to income tax at the beneficiary’s marginal rate.

As the name suggests, it only applies to lump sum payments, so any death benefits paid as a pension are not tested. This emphasises the importance of being in the right scheme and getting nominations in place so that beneficiaries have all the death benefit options available and, on death of the member before age 75, can receive the death benefits tax free. Beneficiary's drawdown avoids LSDBA testing and gives maximum flexibility in how much and when benefits are drawn.

Losing enhanced protection

Before 6 April 2023

Enhanced protection was normally lost if:

• 'relevant benefit accrual' occurred
• certain types of pension transfer were received/made or
• the individual became a member of a new pension arrangement (unless it was a transfer of existing rights)

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

If enhanced protection was lost or revoked, individuals reverted back to the standard LTA, unless they had 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.

From 6 April 2023

From 6 April 2023, enhanced protection normally cannot be lost – individuals who still had valid enhanced protection on this date can now recommence pension funding, make transfers and start new arrangements without fear of invalidating the protection.

The exception to this rule is the unlikely situation where an individual has successfully managed to register for enhanced protection after 15 March 2023 (see later). In these circumstances, the old rules continue to apply and enhanced protection can still be lost.

If lost, this now means the individual would fall back on the standard LSA and LSDBA, unless another transitional protection was held.

Relevant benefit accrual

Before 6 April 2023

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

For defined contribution schemes (DC) this normally meant no contributions 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 had not been significantly altered since A Day - for example, there had been no change to the policy term, contribution levels or cover - protection could be maintained.

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

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

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

The 'appropriate limit' is the value of the member's DB benefits at 5 April 2006. This could 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 allowed the A-Day benefits to be revalued using earnings after 6 April 2006.

If the appropriate limit was exceeded, enhanced protection was lost.

From 6 April 2023

Aside from the exception mentioned earlier, contributions could recommence from 6 April 2023 without losing enhanced protection and the appropriate limit is no longer a concern for those in DB schemes. 

This also gave those with enhanced protection the potential to carry forward unused annual allowance from the three tax years before 2023/24 when they were unable to fund their pensions.  

Enhanced protection and transfers

Since 6 April 2023, transfers do not normally affect an individual’s enhanced protection - with the exception mentioned earlier.

Even before 6 April 2023, individuals with enhanced protection would normally be protected if they transferred their benefits to another scheme. But, the transfer had to be a permitted transfer.

The transfers that would have resulted in a loss of enhanced protection were:

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

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

Partial transfers from DB schemes

Before the Spring Budget 2023 changes, where the value of a 'permitted transfer' exceeded the appropriate limit, enhanced protection was lost. But to avoid this, a partial transfer could have been considered to ensure protection was maintained.

Not all schemes offered this but, where it was available, individuals could 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 was still the potential to lose enhanced protection, so care was needed when taking benefits. This generally meant crystallising all the benefits in the DC scheme before triggering a further appropriate limit test on the remaining DB scheme. This ensured that the DC scheme could be taken under enhanced protection, even if the testing of the remaining DB scheme exceeded the 'appropriate limit'.

Divorce

Enhanced protection was not affected if someone became subject to a pension debit as a result of a pension sharing order. But, before 6 April 2023, they wouldn't have been able to rebuild their pension benefits without losing the protection.

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

• If a new arrangement was set up before 6 April 2023 to accept the pension credit directly from the original member's pension, enhanced protection was lost - this would still be the case for anyone who has successfully managed to register for enhanced protection (by concession) after 15 March 2023
• But if it was paid into an existing pension arrangement, enhanced protection was not affected. After that, the pension credit rights can normally be transferred to a new arrangement without affecting the protection

Enhanced protection - applications

Individuals normally had to apply for enhanced protection before 6 April 2009. However, a late application for enhanced protection can be made if the individual had a reasonable excuse for not doing so by the deadline and the claim is notified to HMRC without unreasonable delay after the excuse ceased to apply.

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 normally 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 because 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.