Pension transition relief: why HR needs to understand it
Pension transitional relief is probably not a phrase that is regularly bandied about in HR circles. But it arguably should, considering the potentially negative impact on senior hires if its not factored into the recruitment process. It could mean the difference between a successful or failed hire. And that, in turn, will inevitably have implications for corporate reputation...
In short, transitional relief represents a way for individuals to protect their pension pots from potential future changes to certain aspects of the tax regime.
Getting to grips with the way it works, how it can be lost and ways to hang onto it could therefore be very beneficial for all concerned: HR, employer and employee.
What is transitional relief?
It’s a way for individuals to hang on to their pension lifetime allowance (LTA) protection when moving from one employer to another. HMRC has sanctioned this, advising that in order to secure pension LTA protection individuals should not join a new pension scheme or a Registered Group Life scheme.
The Lifetime Allowance (LTA)
The pension Lifetime Allowance – the limit on the amount of benefit that can be drawn from pension schemes without triggering an extra tax charge - has over the years reduced to a level that now affects many more people. And it’s not only pension benefit that counts towards the LTA, lump sum life / death benefits are factored into the equation too.
The LTA was introduced in 2006 at a level of £1.5m and, over the years, has reduced to now stand at £1m. In the November 2017 Budget, the government confirmed that the LTA will rise with inflation, increasing from £1m to £1,030,000 to match the Consumer Prices Index from 2018/19.
The different types of protection
HMRC introduced a way to help individuals protect their pension pots from reductions in the LTA. These protections have changed names over the years but the premise has pretty much remained the same:
- Enhanced Protection 2006 – this protects the old LTA allowance of £1.5m but individuals cannot build up more without paying tax above the standard LTA (i.e. whatever is current) when they take their pension.
- Fixed Protection 2012, 2014, 2016 – as above, but this fixes the allowance at whatever level the LTA stood at when protection is sought. For example, Fixed Protection 2016 fixes the level at £1.25m.
- Individual Protection 2016 – this protects the LTA at the lower of: - the value of an individual’s pension(s) at 5 April 2016; - or £1.25m.
Individuals can keep building up their pension with this protection but they must pay tax on money taken from their pension(s) that exceed their protected LTA.
How are they lost?
Pension LTA protections can become lost on joining a new tax-registered group life scheme in addition to being auto enrolled into a pension scheme. This could happen from day one of employment so it needs to be factored in during the recruitment and onboarding process.
What can be done to keep them?
The prospective employee should declare any protection arrangement they may have prior to joining a new company.
The recruiting employer would need to ensure that instead of enrolling a future employee into any Registered Group Death In Service scheme, a suitable alternative to retaining any protection is offered, such as an Excepted Group Life scheme.
Whose responsibility is it?
It’s the employee’s responsibility to declare any protection they may have in place. There is no onus on the employer to check, but considering the potential for loss on the part of new – and probably senior – recruits, it might be considered prudent to:
- Prompt individuals to identify themselves during the onboarding process. Perhaps consider asking whether any protection applies as part of the job offer literature.
- As a belt and braces move, also consider factoring this aspect into the eligibility requirements for registered group life schemes.
Also, bear in mind that although employers are not duty bound to do any of this, it is the employer’s responsibility to understand the implications with regards to life insurance. Remember that lump sum life / death benefits of a Registered Group Life scheme count towards the LTA. This is often overlooked.
Employers may allow a new recruit to join their Excepted Group Life scheme – even where they don’t have a transitional relief issue – as it could help them mitigate any potential tax issues with regards to the LTA. However, this could be considered tax avoidance by the HMRC.
The pros and cons of an Excepted Group Life scheme
- The benefits don’t count towards the LTA and it won’t have an impact any existing protections.
- It can be considered a significant recruitment benefit, particularly where senior hires are concerned.
- They’re more complicated schemes to run as they’re subject to the inheritance tax (IHT) regime (Registered Group Life schemes aren’t). Therefore, as an employer or pension scheme trustee it’s important to get detailed advice on how to deal with the IHT charges that would apply.
- The scheme needs to be set up correctly to ensure that it cannot be viewed as tax avoidance (i.e. by including those with LTA issues, rather than just those with transitional relief issues).
On the latter point, some employers are being advised to put everyone into an Excepted Group Life Scheme so that they can’t be accused of cherry picking.
But this, in turn, effectively increases the potential for it to be considered tax avoidance as there’s a greater chance of people with LTA issues being in the scheme since the allowance was reduced.
It’s also worth bearing in mind that the structure and even existence of Registered and Excepted group life schemes could change in future, following the outcome of the government’s taxation of trusts announced in the November Budget. The goal is for a simpler, fairer and more transparent structure.
Reports suggest that some insurers will be calling for the preservation of the current beneficial tax regime, removing all pension legislation links and maintaining simplicity throughout.
For the time being, the only certainty is that individuals with existing protections need to hang onto them. In order to help with this, employers need to be sure they have the right facilities in place. Considering the complexities and potential future change, expert legal and risk audit consultancy could pay dividends.
What 3 things should employees consider?
- Do you have any pension LTA protection in place?
- 2. If so, you mustn’t join any Registered Group Life scheme or be enrolled into a pension scheme. What alternatives does the prospective employer have in place?
- Is it structured in a way that can’t be considered tax avoidance?
What 3 things should employers consider?
- Do you have the facility in place should a prospective employee declare they have pension LTA protection in place?
- Is it structured in a way that can’t be considered tax avoidance?
- Does the new recruit understand the long-term implications with regards to IHT liabilities? And do you have the ways and means to help?
With over 32 years' experience in the employee benefits sector, Graham is the Commercial Director for Arthur J. Gallagher and is responsible for overseeing the consultancy's risk and healthcare propositions.