Pension simplification is becoming widely regarded as anything but simple and this impression was not helped by the recent publication of technical pages in the Registered Pension Scheme Manual on the Inland Revenue website.
Up to this point the one thing that did appear simple was that in order for a member to benefit from enhanced protection of their pre 5th April 2006 pension entitlement they could not accrue any further benefits under any arrangement post this date. However, the guidance now provided would appear to allow continued membership of final salary schemes and cash balance arrangements with additional contributions and further benefit accrual allowable within certain limits.
The manual provides a flow chart and some worked examples looking at where continued accrual may be possible, such as where the member experiences low salary increases or where an early retirement reduction is applied.
Taking the low salary increase example the member had 30 years service at ‘A’ day based upon 1/60th accrual and a salary of £240,000. The member would therefore register £2.4 million (i.e. £120,000 pension at 20:1) for enhanced protection. The member remained in service for a further 5 years by which time salary had risen to £252,000 giving a pension of £147,000 (i.e. 35/60 x £252,000). The benefit crystallisation value would be £2.94 million.
The test for relevant benefit accrual is whether the value of the benefit crystallisation event is greater than the value of the appropriate limit which is defined as the greater of:-
- Indexation of £2.4 million (x 5% compound, RPI or the percentage rate specified in The Registered Pension Schemes (Defined Benefit Arrangements – Uprated Opening Value) Regulations which to date has not been determined.
- A recalculation of the pension accrued at 5 April 2006 reflecting current final pensionable salary and the scheme early retirement factor (where appropriate) for the current age and a valuation factor of 20.
If the 5% compound figure is used this values the appropriate limit at £3,063,076 (£2.4 million indexed at 5%) which is in excess of the benefit crystallisation event value of £2.94 million so enhanced protection would therefore be retained.
Clearly this is now very complex and generally contrary to most peoples understanding of the regulations based upon previous guidance. Many advisers will be providing their clients with advice based upon this misunderstanding and they need to familiarise themselves with current guidance. At least the manual is clear and helpful and the worked examples and flow charts are a genuine aid to understanding. Unfortunately there is still no guarantee that this basis will be the one finally implemented in April next year.
Advisers need to be aware! The impact of getting this wrong is significant as it would mean that not just the excess over the enhanced protection amount would be subject to the 55% tax charge but the whole amount over the applicable lifetime allowance (LTA). Continuing the example used previously if the benefit exceeded £3,063,076 by even £1 then enhanced protection would be lost and assuming the 2010/11 LTA of £1.80m was applicable this would mean a tax charge of 55% applying to an equivalent excess benefit of around £1.064m. For those affected this needs to be monitored regularly as changes in salary, benefit accrual or retirement date could have a potentially disproportionate and unwelcome impact.
I would suggest anyone advising in this market familiarises themselves thoroughly with the contents of www.hmrc.gov.uk/manuals/rpsmmanual/index.htm and keeps an eye open for any future instalments.
Published in Financial Solutions Magazine November 2005