Primary protection was introduced by Finance Act 2004 to protect those who would exceed the newly introduced Lifetime Allowance from unnecessary tax charges.
- What is primary protection?
- Who was primary protection aimed at?
- How does primary protection work?
- Losing primary protection
- Changes to the protected amount
This form of protection was available to anyone whose total benefits (crystallised and uncrystallised) from registered pension schemes on 5 April 2006 were valued (see below) as equal to, or greater than, £1.5m (the lifetime allowance at 6th April 2006).
It was aimed at individuals:
- who wanted to continue in pensionable employment or accrue benefits in a registered pension scheme after 6th April 2006, and
- were already over the LTA and likely to be so when they took their benefits.
It was also possible to have primary protection over tax free cash. This is covered in protected tax free cash article.
Those who had applied for Enhanced Protection could also apply for Primary Protection. Where this applies the Primary Protection is dormant and does not apply to the individual unless and until the Enhanced Protection is lost or revoked. For more on Enhanced Protection see our Enhanced Protection article.
A member covered by primary protection has a personal Lifetime Allowance (LTA). This is calculated by a Lifetime Allowance Enhancement Factor (LAEF) that is added to the standard LTA. As such, the 'protected' or registered fund value is automatically indexed in line with the LTA.
The LAEF is calculated as follows:
(Value of individual's pension rights at 5 April 2006 - £1.5m) ÷ £1.5m
Example: (£1.7m - £1.5m) ÷ £1.5m = 0.13
Unlike Enhanced Protection , those with primary protection can suffer an LTA tax charge. This would apply to any benefits that crystallise in excess of the personal lifetime allowance.
With primary protection, the amount of protection has increased with the normal lifetime allowance.
However, when the LTA decreased to £1.5 million on 6th April 2012, members with primary protection will retain the protected amount.
This is detailed in paragraph 2, Sch 18 (3) of the Finance Act 2011, which states the underpinned lifetime allowance is the greater of the current standard lifetime allowance and £1,800,000 (the standard lifetime allowance for the tax year 2011-12).
The personal lifetime allowance then applies upon a Benefit Crystallisation Event (BCE). This is calculated by applying the LAEF to the Underpinned lifetime allowance applicable at the BCE date and adding that to the Underpinned lifetime allowance.
The formula to calculate the Personal Lifetime Allowance at the BCE date is: SLA + (SLA x LAEF)
BCE date: 20/08/2012
Underpinned LTA at BCE date: £1. 8m
Personal Lifetime Allowance at BCE date: 1. 8 + (0.13 x 1. 8) = £2,034,000
Therefore, this member may crystallise benefits up to £2,034,000 before incurring any Lifetime Allowance Charge.
Unlike enhanced protection, people with primary protection can continue to have contributions paid to their retirement plans and build up more benefits. There is no tax charge on funds below the level of their personal LTA . So, people with primary protection could continue to earn benefits after 5th April 2006, but if they have benefits greater than their personal LTA, the excess is subject to an LTA charge.
using the member in the example above:
Value of benefits crystallised in 2012/13 tax-year: £2.5m
Lifetime Allowance charge due on excess over personal Lifetime Allowance, i.e. £466,000
If the member did not have primary protection, the lifetime allowance charge would be due on £1,000,000.
Therefore, primary protection has reduced this member's tax charge, but has not eradicated it completely.
Primary protection cannot be revoked, unlike enhanced protection. The only time that primary protection may be lost is in the event of a pension debit (see below).
Primary Protection can be reduced or lost if there is a pension debit applied to the members benefits subsequent to a divorce after 5th April 2006. The individual's LAEF is recalculated to take into account the value of the benefits 'given up'.
The way this is done is to redo the factor calculation as described above as it would have been had the debited amount not been included in the value at 5 April 2006 (even though this is not at the same date).
Taking the example from above:
(Value of individual's pension rights at 5 April 2006 - £1.5m) ÷ £1.5m
(£1.7m - £1.5m) ÷ £1.5m = 0.13
There is a pension debit of £100,000 in December 2012.
New factor is:
(£1.7m - £0.1m -£1.5m) ÷ £1.5m = 0.07
If the recalculated value of the member's benefits is higher than £1.5 million, then the LAEF is recalculated taking into account the reduced fund at 5th April 2006.
If the recalculated value of the member's benefits is lower than the underpinned LTA, then the member will lose primary protection and will revert to the Standard Lifetime Allowance, as the factor would be 0.
It is the individual's responsibility to notify HMRC of the pension debit. A new certificate will be issued giving the details of the new LAEF or confirming that the member is entitled to the SLA, thus revoking the old certificate.
Compensation for poorly performing investments
The Taxation of Pension Schemes (Transitional Provisions) Order 2006 modified sections of the Finance Act 2004 for any individual who has given notice to rely on primary protection, where:
- the pension scheme is a money purchase arrangement, (other than a cash balance arrangement) or a hybrid arrangement where benefits provided may be money purchase (but not cash balance);
- an amount is paid into the pension scheme (or is determined as being payable) between 6 April 2006 and 5 April 2009 in respect of poor performance of an investment owned by that scheme;
- the investment was owned by the pension scheme before 6 April 2006 and offered for sale to the public on the open market; and
- the amount of compensation paid is reasonable, which is the level expected to be paid between two unconnected parties (i.e. an open market value).
In such circumstances, the value of the member's benefits at 5th April 2006 can include the value of relevant compensation for poorly performing investments (reduced appropriately in respect of 'other' pension benefits under a hybrid arrangement). The compensation is valued at the date of payment.
The Taxation of Pension Schemes (Transitional Provisions) Order 2006 modified the Finance Act 2004 for any individual who meets the following criteria:
- the individual gives or has already given HMRC notice to rely on a lifetime allowance enhancement factor due to meeting the requirement for relevant overseas individuals from 6 April 2006
- the individual also gives or has already given notice to HMRC to rely on the 'standard' enhanced primary protection requirements
- the individual would have been a relevant overseas individual in the 2005/06 tax year if that regulation been in force during that period.
The modifications prevent an individual qualifying for two lifetime allowance enhancement factors in respect of the same increase in benefits by applying for either one of the two types of transitional protection mentioned above, after this has already been obtained under the other type of protection mentioned.
Para 7 Sch 36, Finance Act 2004
The Registered Pension Schemes (Enhanced Lifetime Allowance) Regulations 2006
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