Techzone

The 'pensions simplification' rules were introduced on 6 April 2006 (A-Day). Prior to this, the occupational pension rules relating to defined benefit (DB) schemes meant that some higher paid employees had built up pension benefits with a value in excess of the lifetime allowance (LTA) at A-Day.

'Enhanced protection' was one of the options available to individuals who wanted to fully protect their pensions from the lifetime allowance tax charge.

The trade-off was that to retain enhanced protection, there could be no further 'benefit accrual' after 5 April 2006. This means:

• For defined contribution (DC) schemes such as personal pensions, SIPPs or group money purchase schemes, no more contributions (by individuals or their employers) could be made
• For DB schemes, benefits could increase, but had to stay below the 'appropriate limit'

If protection was lost, clients had to tell HMRC within 90 days.

Before tax year 2023/24, the transfer from DB to DC was one occasion when there was a test against the appropriate limit, and if DB benefits exceeded the appropriate limit, enhanced protection was lost.

However, there wasn't an LTA tax charge at this point. This only happened when benefits were crystallised above the standard LTA. To prevent potentially large tax bills in the future, it was therefore important to check the limit before recommending a transfer.

In the 2023 Spring Budget, the Chancellor announced that the LTA would be abolished from 6 April 2024. For the 2023/24 tax year, pension schemes will still carry out LTA checks when benefits are crystallised, but LTA tax charges will no longer apply.

Also, from 6 April 2023, those who still hold enhanced protection can now have relevant benefit accrual without fear of losing their protection. This means that benefits in excess of the appropriate limit can be paid without affecting the protection, as can transfers – effectively making the appropriate limit irrelevant.

The exception to this is the very unlikely situation where someone has successfully registered for enhanced protection (by concession) after 15 March 2023. For these individuals, the protection can still be lost.

The remainder of this guide is therefore largely for historical reference.

Calculating the appropriate limit

The appropriate limit was designed so that no-one who gave-up DB accrual before A-Day (6 April 2006) should lose enhanced protection.

Deferred pensions that only increase by statutory revaluation, or in line with the scheme rules, didn't break the limit. The limit calculation reflected this.

The limit at A-Day

Firstly, calculate the individual's DB benefits at A-Day.

• Do the calculation as if they had retired and taken their pension on 5 April 2006 - with no early retirement factor.
• Use pensionable service, and pensionable salary, prior to A-Day (as set out in the scheme rules).
• Enhanced protection could only be granted if benefits were within the pre A-Day HMRC limits. Any excess scheme rights had to be surrendered before protection could be applied for. If this had happened, the pension for the appropriate limit was the amount after any surrender.

The A-Day appropriate limit was 20 times this pension. If the DB scheme promised a pension plus separate tax-free cash sum (for example 80th pension + 3/80th cash schemes), the amount of separate lump sum promised was added.

Increasing the limit to the transfer date

The A-Day limit was then increased up to the date DB benefits were taken or transferred (the 'relevant event date') by the higher of:

• RIP: The 'relevant indexation percentage'- 5% a year compound (or RPI if higher) – which effectively reflects statutory revaluation on the deferred pension, or
• PCEL: A benefit recalculation using the 'post-commencement earnings limit' rules (see below).

Benefits subject to statutory revaluation, like GMPs, could be increased in line with the statutory revaluation if this was higher.

Using the PCEL rules

The PCEL rules allowed the limit to be recalculated using the lower of:

• the client's pensionable salary at the relevant event date (calculated as set out in the scheme rules as they stood as at 5 April 2006), and
• salary calculated using the PCEL rules set out below.

This allowed pay increases after A-Day to come into the limit calculation - but benefits built-up, or benefit changes made, after 5 April 2006 still had to be excluded.

Under the PCEL rules, salary could generally be recalculated using the member's best consecutive 12 months' earnings in the three years ending on the relevant event date (or, if earlier, the date the member left the pensionable employment or died). But this was capped at the higher of:

• 7.5% of the standard LTA (or £1.8M if higher) in force on the relevant event date, or
• the average yearly earnings for the 3 years ending on the relevant event date (or, if earlier, the date the member left the pensionable employment or died).

Earnings cap: If the client was subject to the old 'post-89' benefits regime under the DB scheme, the 7.5% PCEL cap applied (with no alternative averaging option).

Early/late retirement or transfer: If the PCEL rules were being used on early or late retirement, any early or late retirement factor that would have applied under the DB scheme rules as they stood on 5 April 2006 had to be applied to the appropriate limit calculation. The same factor had to be applied on transfer before or after the DB scheme normal pension age.

The scheme would have been able to do this for you, but let's look at an example calculation to bring this to life.

How partial transfers were able to help

DB rights were only tested against the client's appropriate limit when they were transferred or came into payment. So, where a client's DB transfer value was above their appropriate limit, they could still make a partial transfer up to the limit without affecting their enhanced protection.

• Only the amount transferred was tested against the limit. If the partial transfer was within the limit, the client's enhanced protection was maintained.
• The transferred funds could grow without limit under the new DC pension, with no impact on the protection.

This gave the client access to pension flexibility with at least some, possibly most, of the value of their DB wealth.

The client's retained DB rights still had to be tested against their remaining appropriate limit – but only when they came into payment or were transferred (the 'second relevant event date').

• This meant enhanced protection could be lost at that point.
• So it was prudent to ensure the DC pension was fully crystallised before the remaining DB rights were taken (or transferred) – to protect the DC rights against LTA tax.

But this could have been a long time in the future. And a quirk in the legislation meant the retained DB rights could be back within the limit by the time they were taken.

Partial transfers – how the limit test on the retained DB rights worked

When the retained DB rights were taken (or transferred), they were tested against:

• the total appropriate limit revalued to the second relevant event date (on the RIP basis – the PCEL rules couldn't be used after the first relevant event);

less

• the amount of the original partial transfer (with no indexation).

So effectively a frozen amount (the original partial transfer figure) was deducted from a growing limit.

Over time, this could bring the remaining DB rights back within the limit – or allow another partial transfer later. The longer the gap between the original partial transfer and the limit test on the retained DB, the more likely it was that they would be within the revalued limit.

Let's revisit our example of Peter: