Deferred DB Pension, LTA and Redundancy - a conundrum

[BrummieDave]

I have a current conundrum which is vexing the (alleged) smartest brains in my company's pensions department as well as our scheme administrators:

A member of a closed DB scheme with deferred pension has applied for and been granted Fixed Protection (which therefore prevents future contributions) is made redundant. Under the scheme rules, at redundancy the pension is augmented by up to 5 years additional service. Under such circumstances is the member's Fixed Protection lost?

I assume that if the newly augmented pension takes the total value above the LTA, the member will pay tax on any pension above their LTA. What nobody seems clear on is whether the very nature of enhancing a DB pension after the member has been granted Fixed Protection counts as making an additional contribution and with this, the member's Fixed protection is lost.

If a member has Fixed Protection 2014 (an LTA of £1.5m) and a redundancy triggered pension augmentation caused this protection to be lost, if that reverted to the standard lifetime allowance of £1m that could be significant (and potentially make the enhancement worthless).

Anyone know the definitive position please; this is concerning a number of colleagues of mine.

[TedSwippet]

HMRC Pensions Newsletter 50 from 2011 suggests that the redundancy payment into the pension "may" trigger benefit accrual that could then invalidate fixed protection:

However, other enhancements (such as enhanced benefits on redundancy or a one-off increase in pension rights in exchange for the individual foregoing the right to future non-statutory pension increases) awarded before benefits are taken may trigger benefit accrual.

The member will normally have acquired a prospective right to the enhanced benefits at some point in time before they come into payment. This means there is an increase in the individual’s prospective rights.

As the benefit accrual test is an ongoing one it applies to any increase in rights right up to the moment benefits are taken. If the increase exceeds the relevant percentage then fixed protection will be lost.

What the "may" in the first paragraph hinges on, though, seems about as clear as mud. I don't navigate DB pension waters generally, so perhaps it makes more sense to you than to me.

[DrBunsenHoneydew]

DB schemes lose their fixed protection if the pot increases in any year by more than CPI (or a higher figure specified in the scheme rules for deferred members - FP is usually taken out by deferred members and CPI indexation is the common position).

So a substantial input on redundancy will very likely blow out the fixed LTA (even if the deemed pot value is still less than the fixed LTA after the redundancy contribution - it is the excessive change in pot that causes the fixed LTA loss, not its absolute value).

[BrummieDave]

Thank you both.

The implication is quite disconcerting. If a deferred member had Fixed Protection 2012 they would have a LTA of £1.8m (and a deferred member with FP14 a LTA of £1.5m etc.).

An input at redundancy that increased the total pot by more than CPI could therefore eliminate the LTA and I assume the current LTA of £1m would kick-in? So everything above £1m would be taxable?

That seems potentially quite disadvantageous, and the member presumably could even be financially worse off as a result? I can't quite get my head around that, or the conditions under which the member would be better off rejecting the enhanced pension.

[TedSwippet]

An input at redundancy that increased the total pot by more than CPI could therefore eliminate the LTA [protection] and I assume the current LTA of £1m would kick-in? So everything above £1m would be taxable?

If fixed protection is lost, the current LTA applies. It is supposed to rise with inflation starting next year, but then so was the £1.5mm initially implemented in 2006 and look what occurred, so I'll believe it when I see it.

The way the LTA penalty tax is designed is that it is 25% of the excess over the LTA. So for a person with a pension pot valued at over £1.8mm today and with FP2012, losing fixed protection would expose £800k to this LTA penalty, for a tax cost increase of £200k. Not small change, then. For FP2014 the tax cost increase is £125k, and for FP2016, £62.5k. Also not small change.

As mentioned earlier, I don't know the specifics of how exactly this applies to DB schemes, having only DC pensions myself. The picture doesn't look rosy -- nothing around the LTA ever is -- but maybe DB schemes have some ways around this that I'm not aware of? DC schemes certainly do not, but then, involuntary loss of LTA protection at least looks a bit easier to avoid in a DC-only world.

[BrummieDave]

Thanks again.

Any DB experts out there who can shed further light on this, particularly if there are ways to avoid the involuntary loss of FP?

[parallellines]

Hmmm. If there was a simple answer to this then it would mean that the purpose of the lIfetime allowance and transitional protections could be just as easily circumvented.

For some transitional protections there is a carve out for deferred members that means any increases in the scheme rules that were previously in place before the LTA reduction are automatically permitted. Details differ from one protection to the next. I've no idea if this applies here. For one thing, the member affected is presumaby still in employment so may not be a "true" deferred pensioner.

Failing that, one option would be to find a way by which the increase in the pension could be waived , and push for a increased redundancy payment to take account of the waiver. Even that might not be easy to implement.