Your useful guide to Lifetime Allowance Protection and Pension Sharing Orders

Rules governing how Pension Sharing Orders might affect pension Lifetime Allowance Protection can be tricky to navigate. Here’s a useful explainer of the key issues.

In a surprise move in the 2023 Spring Budget, the chancellor announced the abolition of the pension Lifetime Allowance (LTA). The government removed the LTA tax charge in 2023/24, before abolishing the LTA entirely from the 2024/25 tax year.

 

Previously, the LTA had restricted the maximum pension benefit that an individual can accrue over their lifetime before a tax charge was made. The tax charge could have been up to 55% of the pension value over the LTA.

 

Overall, the abolition of the LTA is likely to mean that pensions become an even more valuable asset on divorce. The removal of tax charges is designed to encourage individuals to save more in their pensions, potentially making them even more valuable assets on divorce.

 

However, the rules surrounding the LTA can be complex. For example, between the introduction of the LTA in 2006 and the abolition in 2024, individuals were able to take out different types of LTA “protection”.

 

These various types and levels of protection may still affect how a Pension Sharing Order (PSO) will work – keep reading on to find out how the LTA protections work with:

 

  • A Pension Sharing Order debit
  • A Pension Sharing Order credit.

 

Pension Sharing Order against benefits for a pension debit

 

Primary/Individual Protection

 

If a client has Primary/Individual Protection and has their pension benefits reduced as a result of a pension debit, their LTA enhancement factor has to be recalculated.

 

The original valuation for Individual Protection purposes will usually be reduced by the amount of the pension debit – although the value of the debit can sometimes be reduced:

 

  • Individual Protection 2014 – 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.
  • Individual Protection 2016 – 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 £1.25 million (for IP 2014) or £1 million (for IP 2016), protection is lost from that point onwards.

 

Of course, if someone loses IP 2014, they may still be able to apply for IP 2016.

 

Enhanced/Fixed Protection

 

If a client has Enhanced/Fixed Protection, their LTA protection is not affected. Consequently, a PSO gives an individual more headroom for growth.

 

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.

 

The exception is in the highly unlikely situation that the individual successfully registered Enhanced Protection after 15 March 2023.

 

Pension Sharing Order awarded to an individual as a pension credit

 

Primary/Individual Protection

 

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, there will be no change to the amount of Individual Protection the recipient has.

 

Consequently, it could be possible that the increased benefits will exceed the available protection which, before 6 April 2023, could have resulted in an eventual LTA tax charge.

 

It is possible to claim an LTA increase (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.

 

Remember that the new Lump Sum Allowance (LSA) of £268,275 limits the maximum tax-free cash lump sum that an individual can draw from a pension, irrespective of the total value of the fund.

 

However, individuals with Protection will likely have an LSA based on their protected LTA.

 

Enhanced/Fixed Protection

 

In the past, if a client had Enhanced/Fixed Protection, you had to be very careful as to where the PSO was placed. 

 

A PSO is not a “permissible transfer”. So, if a new arrangement was set up to accept the pension credit directly from the original member's pension before 6 April 2023, the recipient would have lost their Enhanced Protection.

 

Instead, the PSO needed to be placed into an existing pension arrangement as a top-up and not set up as an additional policy. 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.

 

Since 6 April 2023, a new arrangement can be set up to receive the pension credit without invalidating Enhanced Protection. The exception is the highly unlikely situation that the individual successfully registered Enhanced Protection after 15 March 2023.

 

  • If protection was in place on 15 March 2023, this no longer applies, as additional contributions are allowed.
  • If protection was applied for after 15 March 2023, no contributions are allowed, so you still need to be careful.

 

Again, remember that the new LSA of £268,275 could apply. However, individuals with protection will likely have an LSA based on their protected LTA. For example, a member with Fixed Protection 2014 will have an LSA of £375,000 (25% of £1.5 million).

 

Get in touch

 

Navigating the rules regarding LTA protection and PSOs can be tricky. So, if you’d like professional help, please get in touch.

 

Email lottie@truefinancialdesign.co.uk or call 07824 554288.

 

As a new mummy, I will be on maternity leave until July 2024, so I appreciate your patience until I am back at my desk.

 

Please note

 

This article is for general information only and does not constitute advice.

 

All contents are based on our understanding of HMRC legislation, which is subject to change.

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