Fixed protection: last minute guidance from HMRC

Introduction

Following concerns raised by the pensions industry, HMRC has issuedguidance clarifying its position on fixed protection and continued life cover.

In this Alert:

• Key points
• Background
• Restrictions on fixed protection
• Why is life cover potentially a problem? 
• HMRC’s latest guidance 
• Example d. – The underlying insurance policy
• What if a fixed protection member’s life cover has already ceased because of concerns over life cover?
• New action plan

Key points

• Fixed protection allows individuals to retain an overall LTA of £1.8 million for pension savings when the LTA reduces to £1.5 million on 6 April 2012.
• New HMRC guidance explains how different types of lump sum death benefits (LSDBs) will be classified, identifying those lump sums which will not jeopardise fixed protection (as well as those which might).

Background

The LTA is the total amount of tax relieved pension savings that an individual can build up over their lifetime without incurring an additional tax charge.

Fixed protection was introduced to allow individuals to maintain an LTA of £1.8 million when the LTA reduces on 6 April 2012 but, in return, further benefit accrual is strictly limited.

Restrictions on fixed protection

Fixed protection will be lost:

• in a DC arrangement, if contributions are paid to the scheme by or in respect of the member;
• in a DB arrangement, if the pension and lump sum rights of a member increase by more than the “relevant percentage”1 at any time during a tax year. (The test for benefit accrual can occur at any time up to the point when benefits are actually taken);
• if a new arrangement is established in respect of the individual; and
• on a transfer, subject to certain limited exceptions.

Why is life cover potentially a problem?

DB arrangements

A simple DB LSDB of, say, 4 x pensionable salary, will not jeopardise an individual’s fixed protection. This is because the DB test as to whether there is benefit accrual post 5 April 2012 applies.

However, the DB LSDB must have been in place before 6 April 2012.

DC arrangements

In contrast, the payment of a premium to a DC (or “money purchase”) death benefit after 5 April 2012 will prejudice fixed protection because it falls foul of the DC contribution test.

Hybrid arrangements

Unfortunately, HMRC initially treated LSDBs which are or could be restricted as “hybrid” arrangements (namely, a mixture of a DB and DC arrangement). As such, the payment of any premium post 5 April 2012 towards such arrangements would have triggered the loss of fixed protection.

Fortunately, HMRC has listened to industry concerns and has now issued revised guidance.

HMRC’s latest guidance

Recognising that it is common for schemes to take out an insurance policy to cover the potential cost of paying LSDBs, HMRC has now set out which types of arrangement will still be considered DB.

Examples referred to in the guidance include:

“a. [An] LSDB of 4 x final salary is paid out of scheme funds. This benefit is a [DB LSDB]. (For the purposes of these scenarios the [DB LSDB] is assumed to be a lump sum equal to 4 x final salary, in practice the defined benefit may be different).

b. [An] LSDB is calculated as in a. above and is backed by an insurance policy where, if the policy proceeds exceed the LSDB, the excess is paid to, and retained within, the scheme.

c. [An] LSDB is calculated as in a. above and is backed by insurance policy with the scheme liable to make good any shortfall where the proceeds of the policy are insufficient to fully fund the cost of the LSDB.

d. [An] LSDB is calculated as in a. above and is backed by [an] insurance policy. The policy will not pay out more than the LSDB [(our emphasis)] but may contain restrictions which, if they apply, will result in an amount payable to the scheme (or payable directly to the beneficiary(ies) identified by the trustees) which is less than the unrestricted [DB LSDB].”

Common in DC arrangements, a refund of contributions payable on a member’s death may also count as a DB LSDB provided that, where the scheme rules allow interest or growth to be added, “it is expressed or can be expressed in percentage terms”.

Example d. – The underlying insurance policy

As regards example “d.” above, HMRC go on to explain that the lump sum paid to the beneficiaries after any restriction in the insurance policy is applied should itself be capable of being expressed as a DB LSDB (or satisfy the definition of a cash balance arrangement).

HMRC provides the following examples as to what will amount to a DB LSDB in these circumstances:

• “it represents a percentage of the DB LSDB that would have been provided in normal circumstances;
• it is paid on a pro rata basis;
• it is expressed as a lower amount; or
• the maximum paid under the policy is capped.”

In practice, we would expect the majority of DB LSDBs which are or could be restricted to fall within this definition.

What if a fixed protection member’s life cover has already ceased because of concerns over life cover?

Comfortingly, HMRC confirm that reinstating an individual’s life cover after 5 April 2012 on the basis of its revised guidance will not be regarded as a new arrangement (which would otherwise lead to loss of fixed protection).

However, the life cover:

• must be reinstated as soon as possible whether with the same or a new insurer; and
• the basis of the cover provided must not have been increased in comparison to the cover previously provided.

New action plan

Employers with fixed protection members still need to check their death benefits and seek legal advice on how to proceed. (Trustees should also make sure they understand the position.)

Thanks to HMRC’s revised position fewer fixed protection members will now be affected by the continued life cover problem. However, for those that are, the options for employers (and trustees) as set out in our previous Alert remain2, with any action needing to be taken by 5 April 2012 at the latest.

1 The relevant percentage is the rate specified in the scheme rules on 9 December 2010 by which a member’s rights are increased annually or, where there is no such rate, the annual rate of increase in CPI for the year ending with the previous September’s CPI figure
2 Please see our Alert: “Fixed protection: the life cover problem!” (dated 26 March 2012)