Basically there are two ways being suggested whereby protection can be achieved and individuals may choose whichever suits them best; either Primary Protection, or Enhanced Protection.
Primary Protection is designed for people who at A-Day already have more than the proposed Lifetime Limit of £1.4 million in their pension pots, either in fund value within a money-purchase scheme, or in notional value within a final-salary scheme. Electing to take advantage of the Primary Protection rules will mean that the pre A-Day value of such pension rights will be sort of ring-fenced and allowed to grow in the future in line with the indexation that will be applied to the Lifetime Limit itself. Fair enough. For many people in that position that will be handy.
Enhanced Protection, though, is something that is much more interesting. What this seems to be code for is something like ‘get out of the pension system forever’. People who are prepared to throw in the towel on pensions in this way (by leaving their pension scheme and opting for Enhanced Protection), will be ensuring that all post A-Day fund growth will be free of the Recovery Charge if the benefits are in a money-purchase scheme. For those in final-salary schemes, Enhanced Protection will mean that pre A-Day pension rights will be able to be based on post A-Day pensionable earnings (subject to some restrictions), again without giving rise to the Recovery Charge.
This is very generous and it seems to allow those currently with uncapped pensionable earnings to keep the right to use them for their past-service pension rights, as long as they are prepared to jump ship pension-wise as far as the future accrual of benefits is concerned. Again, fair play, and obviously many people already over the £1.4 million ceiling will be looking carefully at this as a serious option for themselves going forward. All good news, of course, for the pension advisers who will doubtless be an indispensable part of the decision-making process for an increasingly large number of well-heeled clients.
The surprising thing, though, is that Enhanced Protection is also going to be available to people who have not yet reached the Lifetime Limit of £1.4 million. I have decided to refer to these people as having ‘Pensions Momentum’. That is, the value of their pension pots are not yet over the set limit, but as salaries rise or money-purchase returns clock up, they may well exceed it at some time before they reach retirement age. This registers as ‘very interesting’ on the Bee/Richter scale of pensions.
This is all explained in the Revenue’s simplification document by the use of yet another of those marvellous fictitious case studies of ‘real’ people. In this case, Jasmine. In the example, Jasmine has a pre A-Day money-purchase pot of just £1.12 million, but goes for Enhanced Protection anyway. For her, this turns out to have been a good move as, at retirement, her fund has grown to £2 million, whereas the Lifetime Limit has only made it from £1.4 million to a measly £1.8 million. In her case, as she was so smart, there is no Recovery Charge to pay because she put herself outside of the pensions fold on A-Day. Well done Jasmine!
The thing is, though, the decision to opt for Enhanced Protection could just as easily have backfired on her, with her fund only growing to, say, £1.8 million, but the Lifetime Limit soaring to £2 million. In that case Jasmine would presumably be as sick as a parrot about all this and, also presumably, asking awkward questions of the financial adviser who put her up to it in the first place.
I’m very interested in what the regulators will make of all this, particularly as it involves the sensitive subject of advising people to cease active membership of pension schemes. How much Pensions Momentum will people need before they are sure they will go over the limit? And more to the point, how many people are likely to be in the frame for this type of advice? Surely the number of people currently with Pensions Momentum will be much larger than the hotly disputed number already over the £1.4 million ceiling.
Not only that, but people will also be able to give up the Enhanced Protection at any time before retiring simply by rejoining a pension scheme. Given that the moving target of the Lifetime Limit will be fiendishly difficult to get a direct hit on, I can imagine that people might use the Enhanced Protection rules to have a break from pensions for a while and, once they are nearer to retiring, take a check on where they are with reference to the Lifetime Limit and decide at that time whether to get back into pensions or not. It is indeed ironic that in this proposed system based on maximum emerging benefits it will be very difficult indeed for individuals to achieve them. This one will run and run I think.
21 January 2004
This document is based on Scottish Life’s understanding of the tax simplification pension proposals issued up to 10 December 2003. These are only proposals and are subject to consultation. These may change in the future.