If your pension benefits were worth more than £1m in April 2016, it is not too late to avoid a charge when you cash them in.
Were your pension benefits worth more than £1m in April 2016? If so, you may be eligible to apply for protection from the lifetime allowance (LTA) charge normally payable on pension benefits above a set threshold. Since this charge can be as much as 55% of your benefits above the threshold, it is an option that is definitely worth investigating.
First, some background. The LTA is the total value of the pension benefits you can build up in private pension schemes without any liability to additional charges. In money purchase pension schemes such as stakeholder or self-invested personal pensions (Sipps), the relevant figure is the value of your fund. In a defined benefit scheme such as the NHS Pension Scheme, there is a formula for working out what your benefits are worth.
For many years, the LTA was high enough not to worry more than a tiny handful of savers. However, in 2012, the Government began reducing the LTA, cutting it back over several years until 2016, when it was reduced from £1.25m to £1m. Those reductions left many more people liable to the LTA charge, though this is not payable until you draw on pension savings that exceed the LTA or reach age 75 if earlier (or on death before the age of 75 with money purchase pension funds or death in service lump sums).
Crucially, the Government recognised it would be unfair to penalise people who already had pension benefits above the reduced LTA when the reduction in the LTA came into effect. It therefore offered a number of protections and exemptions. Among these, Individual Protection 2016 (IP16 for short) is still available today.
Broadly, if your pension benefits were worth more than £1m on 5 April 2016 you will be entitled to apply for IP16 which protects the value of those benefits up to £1.25m. If successful, you will not have to pay an LTA charge on pension benefits within your IP16 protected amount.
There are caveats here. In particular, you can’t apply for IP16 if you are already benefiting from Primary Protection, another safeguard the Government introduced to prevent unfairness as it reduced the LTA. And if you have successfully applied for another protection – including Enhanced Protection, Fixed Protection 2012, Fixed Protection 2014 and Fixed Protection 2016 – your IP16 will lie dormant. Also, your protection could be reduced, or lost altogether, if you become subject to a pension debit following a divorce in which the courts make a pension sharing order.
Still, for those who are eligible, IP16 could be very valuable, with the potential to reduce your liability to an LTA charge by tens of thousands of pounds. And the good news is that while it is now almost six years since that last LTA reduction, the Government has yet to announce a deadline for applications for IP16; there is still time to secure the protection.
To do so, you will need to have the detail of the value of your total pension benefits on 5 April 2016. That includes the value of your NHS Pension Scheme benefits, so you will need to apply to the scheme for an IP16 valuation. You can do this using the AW295 form available from the NHS Business Services Authority (there is a fee to pay for the valuation). It also includes the value of all other pensions you had on 5 April 2016, so you will need to check this detail too.
For NHS Pension Scheme members who have yet to retire, it is worth applying for IP16 before you complete your AW8 form, through which you claim your retirement benefits. However, if you have already retired, you are still entitled to claim IP16 – in which case, you may be able to reclaim any LTA charge that has been overpaid.
Applications for IP16 can be made via HM Revenue & Customs’ online self-service tool. If successful, you will receive electronic confirmation, including a protection reference number that you can cite when claiming your retirement benefits later in life in order to avoid the LTA charge that would otherwise be payable. HMRC is also looking into how pension administrators could be notified of members’ protection status, or at least given the ability to check it.
If you have any doubts about how to proceed with an IP16 application – or whether you’re eligible – it is worth taking specialist financial advice on your circumstances. This is a potentially valuable protection that could help you take a tax-free lump sum of up to 25% of a higher LTA so it is important not to miss out.
As for the post-2016 rules, the Government has previously indicated a willingness to increase the LTA in line with inflation each year. This has seen the LTA rise to £1,073,100 although there was no increase in the 2021/22 tax year and the Government has announced a freeze in the allowance at this level until at least April 2026.
Content correct at the time of writing and is intended for general information only and should not be construed as advice.