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Pensions Tax Manual

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Protection from the lifetime allowance charge: protecting pre April 2006 pension benefits: enhanced protection: relevant benefit accrual

Glossary PTM000001
   

Relevant benefit accrual
Relevant benefit accrual in other money purchase arrangements
Relevant benefit accrual in hybrid arrangements
Relevant benefit accrual in defined benefits and cash balance arrangements
The crystallisation value of benefits and transfers for the relevant benefit accrual test for defined benefits arrangements or cash balance arrangements
Example of the relevant benefit accrual test for cash balance and defined benefits arrangements
Relevant benefit accrual in defined benefits arrangements and cash balance arrangements: the appropriate limit
Relevant benefit accrual in defined benefits and cash balance arrangements: the earnings re-calculation value
How the earnings recalculation works for a defined benefits arrangement
How the earnings recalculation works for a cash balance arrangement
Relevant benefit accrual under enhanced protection: the post-commencement earnings limit
The post commencement earnings limit for capped members
The post-commencement earnings limit for non-capped members
Relevant benefit accruals in defined benefits and cash balance arrangements: example
Benefit increases after 5 April 2006 that are not relevant benefit accruals: low salary increases: example
Benefit increases after 5 April 2006 that are not relevant benefit accruals: early retirement factor applied: example
Where relevant benefit accrual will occur on benefit crystallisation

Relevant benefit accrual

Paragraph 13 Schedule 36 Finance Act 2004

The test used to see if ‘relevant benefit accrual’ has occurred depends on the type of arrangement under which the individual’s benefits are being provided. There are different rules for:

  • other money purchase arrangements, and
  • cash balance arrangements or defined benefits arrangements.

The guidance that follows explains when relevant benefit accrual occurs in each of these types of arrangement as well as the position for a hybrid arrangement, i.e. an arrangement which eventually will be one of an other money purchase arrangements, a cash balance arrangement or a defined benefits arrangement but which currently makes provision for two or more of these types of benefit. See PTM023000 for details of types of arrangements.

Essentially the relevant benefit accrual test for other money purchase arrangements is an input test. The payment of a contribution on or after 6 April 2006 to this type of arrangement triggers the loss of enhanced protection but not the payment of benefits.

The relevant benefit accrual test for defined benefits arrangements or cash balance arrangements is an output test. So the payment of contributions to these types of arrangement does not trigger loss of enhanced protection but the payment or transfer of benefits may cause loss of enhanced protection. Contributions to these types of arrangement may continue after 5 April 2006 without causing loss of enhanced protection. Benefits may continue to accrue under defined benefits arrangements or cash balance arrangements after 5 April 2006 within certain parameters, but if benefits accrue at more than a set rate, enhanced protection is lost (see below). So by continuing to accrue benefits after 5 April 2006 individuals run the risk of losing enhanced protection when benefits come into payment or are transferred.

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Relevant benefit accrual in other money purchase arrangements

Paragraph 13(a) and 14 Schedule 36 Finance Act 2004

Other money purchase arrangements are money purchase arrangements that are not cash balance arrangements. For these arrangements, investment growth from 6 April 2006 is protected from the lifetime allowance charge.

For other money purchase arrangements, ’relevant benefit accrual’ occurs when a relevant contribution is made after 5 April 2006. A relevant contribution for the purposes of enhanced protection is one of the following:

  • a relievable pension contribution paid by or on behalf of the individual under the arrangement. Rebates and minimum contributions paid into a money purchase arrangement by HMRC are not relievable pension contributions - see Section 188(3)(c) Finance Act 2004. Contributions paid after the member has reached age 75 are also not relievable pension contributions;
  • a contribution to the arrangement in respect of the individual paid by his employer;
  • a contribution paid otherwise than:

    • by the individual (or on his behalf) or
    • by their employer in respect of the individual,
    • which is subsequently allocated to the individual’s arrangement.

There are two exceptions to what counts as relevant contributions, these are:

  • minimum payments under section 8 chapter 48 of the Pension Schemes Act 1993 or section 4 chapter 49 of the Pension Schemes (Northern Ireland) Act 1993 or any amount recovered under regulations made in connection therewith. Where such payments are being made before 6 April 2006 they may continue.
  • certain contributions that are used to provide life cover under a policy of insurance do not count as relevant contributions - see PTM044100.

The payment of compensation into an other money purchase arrangement after 5 April 2006 could be a relievable pension contribution, triggering loss of enhanced protection. Whether it does so depends upon the nature of the compensation (see PTM044100).

The payment of a ‘relevant consolidation contribution’ to discharge the liability of an unfunded unapproved retirement benefits scheme in accordance with paragraph 48 Schedule 36 is a contribution that triggers loss of enhanced protection. Such relevant consolidation contributions had to be made between 6 April 2006 and 7 July 2006.

Where the other money purchase arrangement had formerly been a hybrid arrangement, relevant benefit accrual occurs if a relevant contribution was paid to the hybrid arrangement at any time after 5 April 2006. In these circumstances, enhanced protection is lost as soon as the formerly hybrid arrangement becomes an other money purchase arrangement.

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Relevant benefit accrual in hybrid arrangements

Paragraph 13(a) Schedule 36 Finance Act 2004

Under a hybrid arrangement the type of benefit provided is not known until benefits are actually provided. So a hybrid arrangement could end up providing benefits as either other money purchase, cash balance or defined benefits (depending on what benefits have been promised).

Contributions to hybrid arrangements may continue after 5 April 2006 without immediate loss of enhanced protection. However if when benefits crystallise the hybrid arrangement is found to be an other money purchase arrangement, the contributions paid after 5 April 2006 cause loss of enhanced protection. Protection is lost at the point the hybrid arrangement becomes an other money purchase arrangement.

Where one of the potential benefit options under a hybrid arrangement is other money purchase benefits (money purchase benefits that are not cash balance benefits) there are two possible relevant benefit accrual tests that may apply to the arrangement. These are:

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Relevant benefit accrual in defined benefits and cash balance arrangements

Paragraphs 13(b), 15(1) to (4) Schedule 36 Finance Act 2004

Payments from a cash balance arrangement or defined benefits arrangement that are either:

  • a benefit crystallisation event, or
  • a permitted transfer (see PTM092420) to an other money purchase arrangement

trigger a test for relevant benefit accrual. If relevant benefit accrual has occurred enhanced protection is lost.

Payment of benefits that are not a benefit crystallisation event, for example payment of a dependant’s pension, will not cause loss of enhanced protection. Similarly a permitted transfer to another defined benefits arrangement or cash balance arrangement does not cause loss of enhanced protection.

When does relevant benefit accrual occur?

Relevant benefit accrual occurs when the total value of:

  • the benefit crystallisation events and
  • permitted transfers to other money purchase arrangements

paid from cash balance arrangements and/or defined benefits arrangements in respect of the same employment, or from arrangements related to the employment (see below), are more than the ‘appropriate limit’.

This relevant benefit accrual test is on an employment basis. Usually this means that the value of benefits paid in respect on one employment is compared to the value of the rights as at 5 April 2006 in respect of that same employment (and no other employment).

Some retirement benefits schemes are set up for a number of employers that may or may not be associated. Such schemes may provide benefits that are calculated strictly in respect of each employment held by the individual so that the scheme may provide a number of separate pension entitlements. Alternatively, such schemes may provide benefits for a number of employments held by the individual by calculating total benefits for all the employments by reference to the earnings from the last employment held. Where this is the case, the test for relevant benefit accrual and the value of the appropriate limit will be applied to the benefits paid in respect of all the employments, as if there were a single employment.

Benefits in other money purchase arrangements are not included in this calculation. Neither the benefits paid nor the value of benefits held in these arrangements on 5 April 2006 is included in the relevant benefit accrual test.

Later in this guidance (see Example of the relevant benefit accrual test for cash balance and defined benefits arrangements) there is an example of a relevant benefit accrual test where more than one employer is involved and there is more than one type of arrangement.

For the avoidance of doubt, a ‘relevant consolidation contribution’ paid to a defined benefits or cash balance arrangement between 6 April 2006 and 7 July 2006 to discharge the liability of an unfunded unapproved retirement benefits scheme in accordance with paragraph 48 Schedule 36 increased the benefits provided by the arrangement. If when benefits are crystallised they are more than the ‘appropriate limit’ enhanced protection will be lost.

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The crystallisation value of benefits and transfers for the relevant benefit accrual test for defined benefits arrangements or cash balance arrangements

Paragraph 15(1) to (3) Schedule 36 Finance Act 2004

In the relevant benefit accrual test for defined benefits arrangements or cash balance arrangements the amount of the payments that is compared to the appropriate limit is called the ‘relevant crystallised amount’. The relevant crystallised amount is the total of the crystallised amounts for each ‘relevant event’ - that is benefit crystallisation events and permitted transfers to other money purchase arrangements. (See PTM092420 for more information on permitted transfers).

For a benefit crystallisation event (BCE) the amount crystallised is the amount of the BCE. PTM088000 gives more information on BCEs and the amount crystallised.

For a permitted transfer to an other money purchase arrangement that is not a BCE, the amount crystallised is the total of the:

  • amount of sums, and
  • market value of assets

held for the purposes of the arrangement that is transferred.

A transfer to an other money purchase arrangement that is part of a qualifying recognised overseas pension scheme is a BCE 8.

Transfer of crystallised rights

Article 36 The Taxation of Pension Schemes (Transitional Provisions) Order 2006 - SI 2006/572

Where:

  • a member is in receipt of a scheme pension, and
  • sums and assets representing the pension in payment are transferred in connection with the winding-up of the scheme providing the pension

the relevant crystallised amount in respect of the transferred crystallised scheme pension will be nil.

Relevant events occurring at different times

Where ‘relevant events’ that form part of the total ‘relevant crystallised amount’ occur at different times the value of the earlier event is not changed. There is no uprating in line with the increase in the standard lifetime allowance to take account of the earlier payment.

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Example of the relevant benefit accrual test for cash balance and defined benefits arrangements

Andrew has pension rights under four different arrangements. The benefits relate to two separate employments. On 5 April 2006 these are valued at:

Arrangement 1 - defined benefits: £750,000

Arrangement 2 - cash balance: £250,000

Arrangement 3 - other money purchase: £50,000

Arrangement 4 - defined benefits: £300,000

Arrangements 1 to 3 relate to employer A. Arrangement 4 is in respect of employer B.

Two years later Andrew decides to take benefits from arrangement 1. The value of this benefit crystallisation event is £900,000.

For the relevant benefit accrual test the crystallised value of the benefits paid from Arrangement 1 (£900,000) is compared to the value of all benefits provided by cash balance arrangements and defined benefits arrangements for employer A on 5 April 2006 (£1 million).

The amount of those rights on 5 April 2006 - £1 million - is re-valued in line with the legislation to give the ‘appropriate limit’. The £900,000 crystallised is less than the value of the protected defined benefits and cash balance benefits for employer A, so there is no relevant benefit accrual.

Another two years later Andrew decides to take benefits from Arrangement 2. The crystallised value of these benefits is £350,000. This means Andrew has now crystallised total benefits for employer A worth £1.25 million. (Note that the £900,000 taken two years earlier is not re-valued in line with the increase in the standard lifetime allowance.) The £1.25 million benefits taken is compared to the re-valued amount of the protected defined benefits/cash balance benefits for employer A on 5 April 2006 - the appropriate limit.

The appropriate limit is found to be £1.22 million. As the total benefit taken are more than the appropriate limit there has been relevant benefit accrual and Andrew loses enhanced protection.

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Relevant benefit accrual in defined benefits arrangements and cash balance arrangements: the appropriate limit

Paragraphs 15(4) to (11), 16 and 17 Schedule 36 Finance Act 2004

Regulation 3 The Registered Pension Schemes (Uprating Percentages for Defined Benefits Arrangements and Enhanced Protection) Regulations 2006 - SI 2006/130

The ‘appropriate limit’ is the greater of two values:

  • the indexed amount
  • the earnings recalculation amount.

Where an individual dies having registered for enhanced protection and a lump sum death benefit is paid, the value of the ‘appropriate limit’ may need to be recalculated - see PTM092410.

The indexed amount

The indexed amount is the value of the pension rights in the arrangement(s) on 5 April 2006, as valued by paragraphs 8 and 9 Schedule 36 Finance Act 2004 are increased by an indexation percentage to the date of the benefit crystallisation event or ‘permitted transfer’. The indexation percentage is the greatest of:

  • an annualised increase of 5 per cent from 5 April 2006, or
  • for contracted-out rights, rights subject to revaluation or preserved rights, an annualised increase at the percentage rate in regulation 3 of The Registered Pension Schemes (Uprating Percentages for Defined Benefits Arrangements and Enhanced Protection) Regulations 2006 - SI 2006/130, or
  • the percentage increase in the Retail Price Index from April 2006 to the month in which the benefit crystallisation event or permitted transfer occurs.

The total value of benefits crystallised/transfers made is compared to the indexed amount to see whether or not relevant benefit accrual has occurred.

The earnings recalculation amount

The earnings recalculation amount is the value of the pension rights in the arrangement on 5 April 2006, as valued by paragraphs 8 and 9 Schedule 36 Finance Act 2004, uprated by ‘the earnings re-calculation value’. The value of the pension rights on 5 April 2006 is calculated using pensionable earnings up to that date. Under the earnings re-calculation value, earnings paid after 5 April 2006 can be used to increase the value of pension rights on that date. The value of pensionable earnings may be affected by the post-commencement earnings limits - see Relevant benefit accrual under enhanced protection: the post-commencement earnings limit below.

The earnings recalculation value is set at the point of the first benefit crystallisation event or permitted transfer to an other money purchase arrangement. See below for more information on how the earnings recalculation works.

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Relevant benefit accrual in defined benefits and cash balance arrangements: the earnings re-calculation value

Paragraphs 15(6) to( 11), 16 and 17 Schedule 36 Finance Act 2004

The earnings recalculation value is a calculation of the value of the pension rights as at 5 April 2006 using two assumptions. These are that:

  • the pension rights under the arrangement are calculated as if the individual’s benefits were payable on 5 April 2006 to the individual as if he were the age he had attained when he first takes benefits under the arrangement or transfers out of the arrangement by means of a ‘permitted transfer’ to an other money purchase arrangement; and
  • the amount of the earnings to be used in the calculation of the pension rights is the lesser of:

    • pensionable earnings immediately before the date of first taking benefits under the arrangement or the date of the ‘permitted transfer’, using the definition of such earnings as applied under the arrangement on 5 April 2006; and
    • the ‘post-commencement earnings limit’ as defined in paragraphs 15 and 16 Schedule 36 Finance Act 2004 (see below). This limit does not apply to the calculation of pension rights in statutory schemes and the Parliamentary pension scheme as defined in paragraph 1(1) (c) and (e) Schedule 36 Finance Act 2004 respectively.

If the individual has rights in a number of related arrangements the calculation is made when the first benefit crystallisation event or permitted transfer to an other money purchase arrangement occurs in any of the arrangements.

Permitted transfers after 5 April 2006

Where there is a permitted transfer to a cash balance arrangement or defined benefits arrangement the earnings recalculation works by treating the new arrangement as if it were the same as the old arrangement. Where there is a change of employer and a transfer is made in connection with a relevant business transfer (see PTM092420) the new employment is treated as if it were the same as the old employment. This enables earnings with the new employer to count towards the earnings recalculation test.

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How the earnings recalculation works for a defined benefits arrangement

Paragraphs 15 (6) to (11), 16 and 17 Schedule 36 Finance Act 2004

For the earnings recalculation in a defined benefits arrangement the relevant pensionable earnings received after 5 April 2006 are used to calculate allowable benefits. Pensionable service to 5 April 2006 is used, as is the scheme accrual rate as it stood on 5 April 2006.

Pensionable service accrued after 5 April 2006 cannot be included in the calculation. Any change in the scheme accrual rate after 5 April 2006 is ignored. Any change in the scheme definition of pensionable salary after 5 April 2006 is ignored.

If the member takes benefits before or after their expected retirement date the amount of benefits is adjusted to take account of any reduction or increase required by the scheme rules as they were on 5 April 2006.

Example

On 5 April 2006 Robert has 29 years pensionable service and his benefits accrue at a rate of 1/60th of pensionable salary for each year of pensionable service. Robert’s pensionable salary is £150,000. So on 5 April 2006 Robert has protected accrued benefits of £1.45 million

29/60 x £150,000 = £72,500pa (x 20) = £1.45 million.

Six years later Robert first crystallises benefits. Robert’s pensionable earnings are now £225,000. This gives a pension worth

29/60 x £225,000 = £108,750pa

However Robert is retiring 2 years before his normal retirement date and the scheme rules require Robert’s pension to be reduced by 4 per cent for each year it is paid early. The pension that Robert will receive will be reduced by 8 per cent to account for the fact that it is being paid 2 years earlier than expected. So for the earnings recalculation Robert will receive benefits worth £2,001,000.

£108,750 - 8% = £100,050 x 20 = £2,001,000

Using the earnings recalculation the ‘appropriate limit’ is £2,001,000.

An arrangement may hold a transfer-in on an ‘added years’ basis where the pensionable service credited for the transfer has been calculated using uncapped earnings even though the individual’s earnings are capped for current service. In these circumstances when making the earnings recalculation the number of ‘added years’ credited for the transfer-in may be calculated using capped earnings.

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How the earnings recalculation works for a cash balance arrangement

For a cash balance arrangement the pensionable earnings received after 5 April 2006 are used to determine a revised capital value. The capital value is then adjusted to allow for any reduction or increase required by the scheme rules if the benefits are taken either before or after the member’s normal retirement date.

Example

Henry is a member of a cash balance arrangement where he is promised that an amount of 20 per cent of his final pensionable salary for each year of pensionable service will be made available to provide benefits. On 5 April 2006, Henry aged 59 has accrued 30 years of pensionable service and his pensionable salary is £250,000. His benefits rights on 5 April 2006 are therefore £1.5 million (£250,000 x 20% x 30).

Five years later, Henry, now aged 64 takes benefits. His normal retirement age (NRA) under the scheme is 60. He took no benefits at age 60 and stayed in service. The scheme rules award actuarial increases to benefits deferred past NRA. (The scheme calculates the value of benefits at age 60 using Henry’s pensionable salary at that point and then actuarially increases the benefits for the period age 60 to 64.) The actuarial increase calculated with respect to the scheme rules on 5 April 2006 increases the value of the deferred benefits to £2 million. This will be the appropriate limit using the earnings recalculation.

Where the benefits promised under a cash balance arrangement are not dependent on earnings the earnings recalculation will have no effect. The appropriate limit will be the indexed amount (see Relevant benefit accrual in defined benefits arrangements and cash balance arrangements: the appropriate limit).
 

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Relevant benefit accrual under enhanced protection: the post-commencement earnings limit

Paragraphs 16, 17 and 15(8) Schedule 36 Finance Act 2004

There are two different definitions of the ‘post-commencement earnings limit’. The definition used depends on whether or not on 5 April 2006 the individual was a ‘capped’ member under any scheme providing cash balance or defined benefits in respect of the employment for which relevant benefit accrual is being tested.

A capped member is someone who was subject to the 1989 earnings cap. Other known terms for such a member are 1989 member, post-1989 member or class A member.

Paragraph 16 Schedule 36 defines what the post-commencement earnings limit is for capped members. .

The post commencement earnings limit for non-capped members is prescribed by paragraph 17 Schedule 36 .

Schemes that the post-commencement earning limit does not apply to

The post-commencement earnings limit does not apply to:

  • a relevant statutory scheme (as defined by Section 611A ICTA 1988),
  • a scheme treated by HMRC as if it were a relevant statutory scheme,
  • a Parliamentary scheme or fund mentioned in section 613(4)(b) to (d) ICTA 1988.

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The post commencement earnings limit for capped members

Paragraph 16 Schedule 36 Finance Act 2004

The ‘post-commencement earnings limit’ for capped members is the lower of:

  • 7.5 per cent of the standard lifetime allowance (or, from 6 April 2012, £1.8 million where this is greater than the standard lifetime allowance) when the ‘first relevant event’ occurs, and
  • the individual’s highest earnings from the employment being pensioned in any consecutive 12 months in the three-year period ending with the earliest of:

    • the ‘first relevant event’,
    • the individual leaving the pensionable employment to which the defined benefits arrangement or cash balance arrangement relates, and
    • the individual’s death.

The first relevant event is the earlier of the first benefit crystallisation event or the first permitted transfer to an other money purchase arrangement.

Where the individual died or left pensionable employment before the ‘first relevant event’ the amount of earnings can be increased from the date of death or leaving the pensionable employment (as appropriate) until the date of the ‘first relevant event’. The increase is the greater of:

  • an annualised increase of 5 per cent, or
  • for contracted-out rights, rights subject to revaluation, or preserved rights an annualised increase at the percentage rate in regulation 3 of The Registered Pension Schemes (Uprating Percentages for Defined Benefits Arrangements and Enhanced Protection) Regulations 2006 - SI 2006/130, or
  • the percentage increase in the Retail Price Index.

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The post-commencement earnings limit for non-capped members

Paragraph 17 Schedule 36 Finance Act 2004

The ‘post commencement earnings limit’ for a non-capped member is the individual’s highest earnings from the employment being pensioned in any consecutive 12 months in the three-year period ending with the earliest of:

  • the ‘first relevant event’,
  • the individual leaving the pensionable employment to which the defined benefits arrangement or cash balance arrangement relates, and
  • the individual’s death,

as long as this amount is not more than 7.5 per cent of the standard lifetime allowance (or, from 6 April 2012, £1.8 million where this is greater than the standard lifetime allowance) at the ‘first relevant event’.

Where this amount is more than 7.5 per cent of the standard lifetime allowance (or, from 6 April 2012, £1.8 million where this is greater than the standard lifetime allowance) the ‘post-commencement earnings limit’ for non-capped members is the greater of:

  • 7.5 per cent of the standard lifetime allowance (or, from 6 April 2012, £1.8 million where this is greater than the standard lifetime allowance) at the ‘first relevant event’, and
  • total earnings from the pensionable employment for the three year period ending with the earliest of the three dates shown above divided by three.

The first relevant event is the earlier of the first benefit crystallisation event or the first permitted transfer to an other money purchase arrangement.

Where the individual died or left pensionable employment before the ‘first relevant event’ the amount of earnings can be increased from the date of death or leaving the pensionable employment (as appropriate) until the date of the ‘first relevant event’. The increase is the greater of:

  • an annualised increase of 5 per cent, or
  • for contracted-out rights, rights subject to revaluation, or preserved rights: an annualised increase at the percentage rate in regulation 3 of The Registered Pension Schemes (Uprating Percentages for Defined Benefits Arrangements and Enhanced Protection) Regulations 2006 - SI 2006/130, or
  • the percentage increase in the Retail Price Index.

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Relevant benefit accruals in defined benefits and cash balance arrangements: example

David is a member of a contracted-out defined benefits arrangement with an accrual rate of one sixtieth for each year of service. On 5 April 2006, David has 30 years’ service and his pensionable earnings are £120,000. He takes benefits in April 2011. The arrangement uses the 20:1 valuation factor in section 276 Finance Act 2004.

Step 1

On 5 April 2006, David’s rights are valued at £1.2 million (30/60 x £120,000 x 20).

Step 2

Calculate the ‘appropriate limit’ using the value from Step 1. Two calculations need to be done: the higher of the two is the “appropriate limit”.

The first calculation is increasing £1.2 million by an indexation figure. The indexation figure is the highest figure obtained from a calculation over the period between 6 April 2006 and the date of the relevant event. The indexation figure is the highest of:

  • 5 per cent annual compound interest over the period,
  • [RPI(2) - RPI(1)] / RPI(1)
  • where RPI(2) is the RPI for the month in which the first relevant event occurs and RPI(1) is the RPI for April 2006; or
  • for contracted-out rights, the percentage rate specified in The Registered Pension Schemes (Uprating Percentages for Defined Benefits Arrangements and Enhanced Protection) Regulations 2006 - SI 2006/130.

Assume the highest figure is arrived at by using 5 per cent compound for the five years between April 2006 and April 2011. Indexing £1.2 million in this way gives a figure of £1,531,538.

The second calculation is to use David’s pensionable earnings in April 2011 and apply David’s accrual rate under the arrangement to this. In this instance, the scheme rules would not apply an early retirement factor to David’s pension rights when they come into payment in 2011. David’s pensionable earnings are now £160,000. Assume that this pensionable earnings figure does not exceed the limit on post-commencement earnings. David’s pre 6 April 2006 rights have a value of £1.6 million (30/60 x £160,000 x 20).

The amount of £1.6 million from the earnings re-calculation is higher than £1,531,400 figure from the indexation calculation. So the appropriate limit is £1.6 million.

Step 3

Compare the value of the benefit crystallisation event in April 2011 with the appropriate limit.

Scenario 1: The benefit crystallisation event in April 2011 is worth £1.75 million. Enhanced protection is lost but there is no lifetime allowance charge because the standard lifetime allowance is £1.8 million.

Scenario 2: The benefit crystallisation event in April 2011 is worth £2 million. Enhanced protection is lost and there is a lifetime allowance charge.

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Benefit increases after 5 April 2006 that are not relevant benefit accruals: low salary increases: example

Anthony had 30 years’ service on 5 April 2006. The scheme’s accrual rate was 1/60th for each year of service. His final pensionable salary, as defined on that day in the scheme documentation, was £240,000. He therefore registered £2.4 million (£120,000 x 20) for enhanced protection.

Anthony remained an active member of the pension scheme for another five years until he reached normal retirement age. By this time, his final pensionable salary had grown to £252,000 giving a pension of £147,000 (35/60 x £252,000). The value of the benefit crystallisation event is £2.94 million (£147,000 x 20).

The test for relevant benefit accrual is whether the value of the benefit crystallisation event is greater than the value of the appropriate limit. The appropriate limit is the greater of:

  • indexation of £2.4 million (x 5% compound, RPI or the percentage rate specified in The Registered Pension Schemes (Uprating Percentages for Defined Benefits Arrangements and Enhanced Protection) Regulations 2006 - SI 2006/130, and
  • 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.

For the purposes of this example it has been assumed that indexation at 5 per cent compound gives a higher figure than the recalculation.

The value of the appropriate limit is £3,063,076 (£2.4 million indexed at 5 per cent) which is more than the value of the benefit crystallisation event (£2.94 million). Therefore relevant benefit accrual has not occurred and enhanced protection is retained.

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Benefit increases after 5 April 2006 that are not relevant benefit accruals: early retirement factor applied: example

Matthew had 30 years’ service on 5 April 2006. The scheme’s accrual rate was 1/60th for each year of service. His final pensionable salary, as defined on that day in the scheme documentation, was £240,000. He therefore registered for enhanced protection.

He remained an active member of the pension scheme for another five years until age 55. His final salary grew to £300,000. The scheme operated a normal retirement age of 60. If the accrued pension had been taken as a deferred pension at age 60 the scheme would have paid £175,000 per annum (35/60 x £300,000). However Matthew wanted an immediate pension. The scheme applied its own early retirement factor of 4 per cent per annum for each year that benefits were taken before age 60. Matthew was therefore paid a pension of £140,000, which has a capital value of £2.8 million (£140,000 x 20).

The test for relevant benefit accrual as above meant that a pension of £153,154 per annum (valued at £3,063,076) could have been paid without causing the loss of enhanced protection. Matthew retains enhanced protection.

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Where relevant benefit accrual will occur on benefit crystallisation

An individual may give their scheme administrator details of their enhanced protection certificate and at the time the member provides the certificate enhanced protection is valid. However the administrator knows that when the benefits crystallise enhanced protection will be lost due to relevant benefit accrual. If the administrator knows enhanced protection will be lost they should not pay out benefits on the basis that enhanced protection applies. If the scheme administrator pays benefits without deducting any lifetime allowance charge due they could have no ‘good faith’ defence against any tax liabilities and penalties as they knew that enhanced protection would not apply because the crystallising benefits trigger loss of protection.

How scheme administrators deal with this issue will vary from scheme to scheme as there is no prescribed process. However scheme administrators should be aware that when an individual notifies HMRC of their entitlement to both primary and enhanced protection, because enhanced protection takes precedence over primary protection their certificate will show entitlement to enhanced protection and confirm the dormant primary protection. Individuals may have valid primary protection but not yet have evidence of this. On the loss of enhanced protection such an individual would revert to primary protection. They would need to notify HMRC of this who will then issue a revised certificate showing the appropriate primary protection factors for that individual.

Administrators may choose to notify individuals that when their benefits crystallise they will lose enhanced protection and that if they have primary protection they should obtain a revised certificate from HMRC. On receipt of details of the revised certificate administrators will then be able to pay benefits under the primary protection rules.