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Pension sharing - impact on allowances

With the abolition of the lifetime allowance (LTA) from 6 April 2024 came the introduction of two new allowances which limit tax-free lump sums paid from registered pension schemes – the lump sum allowance (LSA) and the lump sum and death benefit allowance (LSDBA).

The LSA is a limit on certain lump sums paid during the member’s lifetime, whereas the LSDBA also includes certain lump sums paid on death before age 75 and serious ill-health lump sums paid before age 75.

Pension sharing as part of a divorce settlement can affect either party’s allowances. Any 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 individual’s allowances, but it can for some with transitional protection (see below).

There's no adjustment to the amount of allowances that have already been used up by funds that were crystallised before the pension debit, so any relevant lump sums that have been paid will still reduce the individual’s available LSA and LSDBA.

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

Any relevant lump sums taken from the extra benefits an individual receives in respect of a pension credit will count towards the recipient's LSDBA and, in some circumstances, their LSA.

Any part of a pension credit that came from a pension already in payment is called a disqualifying pension credit. No tax-free cash can be paid from disqualifying pension credits and they don’t increase the recipient’s LSA.

However, in some circumstances, the individual can claim an enhancement to their LSDBA - but only where the pension credit was received before 6 April 2024.

The treatment of the pension credit for LSDBA purposes depends on whether the pension credit rights were acquired:

• before 6 April 2006, or
• between 6 April 2006 and 5 April 2024 (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).

Pension credit acquired between 6 April 2006 and 5 April 2024

Someone who received a pension credit during this period can only claim an increase to their LSDBA (before 6 April 2024, 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. The factor is calculated by dividing the pension credit by the standard LTA for the tax year in which it was received. If the individual had any of the fixed protections or individual protections in place at that time, their protected LTA replaces the standard LTA in the calculation.

The factor is rounded up to two decimal places.

(Note that, when the regulations abolishing the LTA were originally introduced, they stated that if applying for an enhancement after 5 April 2024, the pension credit would be divided by £1M to calculate the pension credit factor - this has since been amended and backdated). 

To claim the increase, a completed form APSS201 must be sent to HMRC no later than 5 April 2025.

The individual will have their normal LSDBA plus an additional amount calculated by multiplying the pension credit factor by the LSDBA. Their LSDBA will simply be calculated as:

LSDBA + (LSDBA x pension credit factor)

If the individual has a larger LSBDA than the standard, because of transitional protection, then their protected figure replaces the LSDBA.

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 LSDBA when benefits are crystallised.

Pension sharing and enhanced protection

Receiving a pension credit

Since 6 April 2023, enhanced protection normally won’t be affected by receiving a pension credit. The exception is the very unlikely situation where HMRC have accepted an individual’s application for enhanced protection after 15 March 2023, in which case the pre-6 April 2023 rules still apply.

Before 6 April 2023, care was needed.

• If the pension credit was paid from the original member's pension into an existing pension arrangement of the recipient, their enhanced protection was 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, the recipient will have lost their enhanced protection.

Being subject to a pension debit

Enhanced protection is not affected by a pension debit.

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.

This allows them to rebuild their pension savings.

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 – their LSA and LSDBA are unaffected.

However, it's possible to claim an enhancement (known as a pension credit 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 between 6 April 2006 and 5 April 2024.

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 enhancement factor under primary protection.

Being subject to a pension debit

If someone has primary protection and their pension benefits are reduced because of a pension debit, their primary protection 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 on 5 April 2006 and then recalculating the enhancement factor using this new, lower, benefit value. When testing any relevant lump sums against the LSDBA after the pension sharing order has taken effect, the amount available will be based on their reduced primary protection enhancement factor. If tax-free cash rights were registered under primary protection, the LSA is unaffected by the pension debit, unless it results in a loss of protection.

Primary protection will be lost if the pension debit reduces the value of the member's pension rights on 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

Since 6 April 2023, fixed protection (2012, 2014 and 2016) normally won’t be affected by receiving a pension credit.

However, for those who registered their fixed protection after 15 March 2023, it can create issues. The effect on fixed protection of receiving a pension credit on divorce for these individuals 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 enhancement (known as a pension credit factor) to their LSDBA 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 enhancement factor that will give them an increase on top of their protected LSDBA 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.

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.

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 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.

But it's possible to claim an enhancement (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 LSDBA. However, it doesn't give any higher entitlement to tax-free cash - the LSA is unaffected.

Being subject to a pension debit

If someone with individual protection has their pension benefits reduced because of a pension debit, their 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 FP2016 and/or 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.