Enhanced protection was introduced by Finance Act 2004. Individuals who were eligible and continue to hold enhanced protection will not suffer any lifetime allowance excess tax charge when they take pension benefits in excess of the lifetime allowance.
- Anyone could apply for enhanced protection regardless of the value of their funds on 5 April 2006.
- Where someone has enhanced protection any benefits they take are not tested against the lifetime allowance and there will never be an LTA excess charge.
- Members needed to surrender their excess rights before applying to HMRC for enhanced protection.
- Enhanced protection can be lost or revoked under certain conditions. If this happens, members have 90 days to let HMRC know, or they face a financial penalty.
- Contributions or benefit accrual after 6 April 2006 will cause the loss of enhanced protection.
- Auto-enrolment can also cause the loss of enhanced protection, unless an employee opts out within one month. Exceptions to this rule were introduced in 2015, including the ability to make auto-enrolment optional.
Why was enhanced protection introduced?
Enhanced protection was introduced for people who, at 5 April 2006, expected their pension benefits to be over the newly introduced lifetime allowance (LTA) when they intended to take them and wanted to avoid an LTA excess charge.
What is enhanced protection?
Anyone could apply for enhanced protection, regardless of the value of their funds, until 5 April 2009. It has the effect of eliminating any lifetime allowance charge, so effectively a member could take an unlimited amount from their pension arrangements after April 2006.
Providing enhanced protection isn’t lost or revoked, there will be no test against the LTA and therefore no lifetime allowance charge payable.
It was possible to make contributions and have benefit accrual up until 5 April 2006.
The benefit of enhanced protection
The tax charge on £450,000 would be charged according to how the excess was realised
- 55% if taken as a lump sum = £247,500 charge
- 25% if taken as income = £112,500 charge.
It was also possible to have enhanced protection over tax-free cash – you’ll find more about this in our Tax-tree cash and protection article.
Who was enhanced protection aimed at?
- People who had pension benefits at 5 April 2006 that exceeded the 2006/2007 lifetime allowance of £1.5 million, or believed they might exceed the standard lifetime allowance in the future, and
- Were prepared to cease all future contributions to registered pension schemes and / or limit future accrual within defined benefit schemes (further permitted increases in benefits are subject to a ceiling limit known as relevant benefit accrual).
Surrender of excess rights
Before a member could apply to HMRC for enhanced protection, they had to surrender any excess rights.
Paragraph 12(5) schedule 36 FA 2004
The following surrenders of rights don’t count as a surrender of relevant excess:
- under a pension sharing order
- to provide an increased pension to a dependant
- by transferring to another arrangement
- by an assignment
- by giving up rights held prospectively by the member as a dependant of a scheme member.
The amount surrendered shouldn’t be more than the amount of the relevant excess. That’s the amount by which the member's entitlement on 5 April 2006 exceeded the maximum permitted pension.
The excess may have been:
- paid to a sponsoring employer, providing this was allowed under the Authorised Surplus Payments Regulations; or
- refunded to the member if the excess benefits were additional voluntary contributions.
HMRC Pension Tax Manual PTM092410
Losing enhanced protection
Examples of where enhanced protection may be lost are:
- if there is benefit accrual which exceeds the permitted limit defined as relevant benefit accrual
- if contributions are made to any defined contribution arrangement (including any employer / third party contributions - further details below of some exceptions to this rule)
- if a new arrangement is set up for the member (except in the case of certain transfers)
- some transfers.
The member must inform HMRC if they lose enhanced protection. They must do this within 90 days, or they are liable to a penalty of up to £3,000.
HMRC Pension Tax Manual PTM092420
Alternatively, the member can notify HMRC that they no longer wish to rely on enhanced protection (The Registered Pension Schemes (Enhanced Lifetime Allowance) Regulations 2006).
Relevant benefit accrual
Enhanced protection is lost if relevant benefit accrual occurred after 6 April 2006.
For money purchase schemes this means no contributions can be made by the member or anyone else, including their employer. There are exceptions for National Insurance rebates, minimum contracting out contributions and some compensation payments. Certain contributions to life assurance policies providing death benefits (if they were established pre April 2006) don’t count as contributions either.
For defined benefit schemes, the test to see if relevant benefit accrual has occurred isn’t performed until:
- the member crystallises benefits from the arrangement; or
- a permitted transfer is made to a money purchase arrangement.
The amount crystallised or transfer value paid is then compared to the appropriate limit.
The appropriate limit is the greater of:
- the indexed amount or
- the earnings recalculation amount.
The indexed amount is calculated by taking the value of the benefits at 5 April 2006 and increasing them by the greater of 5% or RPI (there is a different increase percentage for the contracted out benefits – see SI 2006/130).
The earnings recalculation amount is calculated by taking the value of the benefits at 5 April 2006 and recalculating them using earnings after 6 April 2006.
Active member of a defined benefit scheme
In practice, most members with enhanced protection who are active within a defined benefit scheme after 6 April 2006 will lose enhanced protection once their benefits crystallise. This is because the benefits they would have accrued after April 2006 will be in excess of the allowable limits. The exception would be where there have been low increases in pensionable salary.
Deferred member of a defined benefit scheme
Any deferred member of a defined benefit scheme will have their deferred benefits increased each year, usually in line with the statutory minimum. This would mean the value of their benefits remain within the 5% or RPI limit.
Enhanced protection is lost if a new arrangement is set up for the member other than to accept a permitted transfer.
This could happen where an arrangement was created to accept a pension credit on the divorce of an individual – see section on enhanced protection and pension debits/credits.
1. Transfers that aren’t ‘permitted transfers’.
A transfer that isn’t a permitted transfer will result in the loss of enhanced protection.
A permitted transfer is:
- where all pension rights relating to the individual under the scheme (not arrangement) are transferred
- the sums are transferred to form assets under a registered money purchase arrangement or a recognised overseas scheme
- the sums are transferred to a defined benefit / cash balance arrangement but only if the originating arrangement was a defined benefit / cash balance arrangement and was winding up and the receiving arrangement relates to the same employment as the originating one
- the sums are transferred to an insurance company and used to buy a scheme pension (so benefits have crystallised) as a result of the scheme winding up, and
- where defined benefit or cash balance rights are transferred to a money purchase arrangement and the rights in the new scheme are actuarially equivalent to the rights being transferred.
2. The arrangement receives an impermissible transfer.
An impermissible transfer made into an arrangement results in the loss of enhanced protection.
The following are impermissible transfers into a money purchase arrangement:
- a transfer of sums from a registered arrangement not relating to the individual (except as a result of a pension sharing order)
- a transfer from a non-registered scheme
- the payment of a transfer lump sum death benefit into the individual's arrangement.
If a defined benefit or cash balance scheme became a money purchase arrangement after 6 April 2006, or a hybrid scheme accepts one of the above types of transfer and the arrangement later becomes a money purchase arrangement, then this would be classed as an impermissible transfer.
What happens when enhanced protection is lost?
When enhanced protection is lost:
- any future benefit crystallisation events (BCE) may be subject to a lifetime allowance charge
- if the member also has dormant primary protection, ie they held both protections, they would revert to primary protection
- if the member intends to apply for Individual Protection 2014 (IP14) or Individual Protection 16 (IP16) this would act as dormant protection, so on the loss of enhanced protection they would revert to IP14 or IP16
- if there’s no dormant protection she would revert to the standard rule
- tax-free cash would be up to 25% of the available standard lifetime allowance or any scheme specific entitlement where this applied (see our article on Tax-free cash and protection).
At any BCE after enhanced protection has been lost, the amount of the available lifetime allowance under section 219 Finance Act 2004 is calculated in the usual way. Even though the member had enhanced protection, the scheme administrator will still have given them the amount of standard lifetime allowance used at any BCE.
Any earlier BCE that occurred with the benefit of enhanced protection doesn’t need to be revisited.
Enhanced protection and pension debits / credits
Any contribution or benefit accrual occurring after 6 April 2006 for a member with enhanced protection will result in the loss of enhanced protection.
Defined benefit or cash balance arrangement
If the member is in a defined benefit or cash balance arrangement and subject to a pension debit after 6 April 2006, they may be able to rebuild their pension rights without losing enhanced protection. This is because accrual is based on increase in benefits, not actual contributions made.
As the relevant benefit accrual test for these arrangements isn’t performed until a BCE takes place, it’s only at that point, ie when the appropriate limit is tested (see Losing enhanced protection above), when it is determined whether enhanced protection has been lost due to rebuilding pension debit rights. However there is a risk that when benefits come into payment they’ll be more than the allowable amount and enhanced protection may be lost.
As any contribution into a money purchase arrangement that isn’t cash balance constitutes relevant benefit accrual, it’s not possible for the member to rebuild their pension rights following a pension debit.
If someone receives a pension credit for a pension sharing order after 5 April 2006, the impact on their enhanced protection will depend on how the credit is received.
- If the pension credit is transferred into a new arrangement then enhanced protection will be lost due to the establishment of a new arrangement.
- If the pension credit is transferred into an existing money purchase arrangement, enhanced protection won’t be lost, as this isn’t a relevant contribution,
- If the pension credit is transferred into an existing defined benefit or cash balance arrangement, enhanced protection may be lost at a later stage if relevant benefit accrual occurs.
Enhanced protection and auto-enrolment
Auto-enrolment was introduced in the Pensions Act 2008, and the first employees started to be auto-enrolled from October 2012. If an employee has enhanced protection and they are auto-enrolled, ’they will have to opt out within the one month opt-out period. Otherwise ’they will lose their enhanced protection, as this would be a contribution to a pension scheme.
In April 2015 the Department of Work and Pensions introduced technical changes to auto-enrolment legislation, listing four new exceptions that modify some of the employer duties where a worker meets specific conditions. One such condition is where the employer has reasonable grounds to believe the worker has primary, enhanced or fixed protection on pension savings under HMRC rules. This allows auto-enrolment to become optional and not compulsory.
It’s the employee’s responsibility to inform the employer if they have protections. Then the employer must decide:
- whether to auto-enrol or re-enrol the jobholder
- what are reasonable grounds to believe the jobholder has enhanced protection, fixed protection or fixed protection 2014/2016. A copy of the HMRC certificate is one such way to demonstrate reasonable grounds.
HMRC Pension Tax Manual PTM092420 and TPR Auto-Enrolment Detailed Guidance 7 - Opting Out.