“New FOI reply reveals over 100,000 savers could face shock six figure tax bills following tiny uplifts to their pension – urgent need for clarity from HMRC”

An FOI reply supplied to Royal London shows that over 100,000 people have secured ‘Fixed Protection’ against past cuts in the Lifetime Allowance for tax relief purposes. But this protection could be invalidated if they see an increase in their pension rights following a recent court case.

In December 2018, in a now famous case brought by Lloyds Bank employees, the High Court ruled that pension funds needed to make changes to eliminate inequalities between men and women brought about by the rules around Guaranteed Minimum Pensions (GMPs). In many cases this could mean relatively modest changes to the amount of pension which people will receive. But even a tiny change could invalidate someone’s longstanding protection against past cuts in limits on pension tax relief, landing them with a huge tax bill.

When the Lifetime Allowance (LTA) for pension tax relief was cut from £1.8m to £1.5m, then £1.25m and then £1m, those who already had high levels of pension saving were allowed to ‘lock in’ those higher limits by schemes known as ‘Individual Protection’ and ‘Fixed Protection’. But one of the conditions for Fixed Protection is that the taxpayer does not accrue any further benefits in future. According to Royal London, there is a risk that the process of GMP equalisation – which could, for example, slightly increase someone’s pension at retirement - would count as an accrual which would invalidate the protection. If someone’s tax relief limit suddenly fell from £1.8m to the current £1.03m, they could face a 55% tax charge on the difference – a bill of £423,500.

There is evidence that the Government is aware of this problem but has not yet taken action.

The DWP, in its consultation paper on DB benefit simplification in December 2018, hints at this problem where it says:

241. We continue to work with HM Revenue and Customs to investigate whether changes might be necessary to tax legislation for those potentially negatively affected by GMP conversion as a result of benefit changes and corresponding Lifetime Tax Allowance and/or Annual Allowance requirements. (p64)

Steve Webb has been in correspondence with HMRC about this issue and they refuse to confirm or deny whether this could be a problem. In their initial reply, HMRC simply said:

“We are currently considering the potential tax implications of individuals receiving an increase in their pension, following GMP equalisation to address gender inequalities. This includes any consequences for the LTA and associated protections. We will publish information, and any guidance necessary, through our usual Pension Schemes Newsletters as soon as possible.”

And in a shorter follow-up reply they said:

“While we are considering any potential implications of GMP Equalisation, including on the LTA, it would not be appropriate at this point to confirm whether there is a potential issue. We will publish further information as soon as possible”.

Whilst many schemes will take time to go through the process of GMP equalisation, some schemes had equalised even before the Lloyds Bank judgment, and more are expected to follow. Unless HMRC resolves this matter urgently, someone could face a huge and unexpected tax charge of this sort at any point.

Commenting, Steve Webb, Director of Policy at Royal London said:

‘This issue combines two of the more complex areas of pensions – GMPs and pension tax relief limits. But that combination could result in a catastrophic tax bill for someone who had acted entirely in good faith. It would be absurd and perverse if a small and unrequested pension boost in response to a court judgment meant that a scheme member suddenly faced a huge tax bill. It is not good enough for HMRC and DWP to be discussing this issue and thinking about issuing guidance. Taxpayers need to know where they stand as a matter of urgency’.

The FOI reply received  by Royal London gave figures for the numbers of people who had obtained Fixed Protection at 2012 levels (£1.8m), 2014 levels (£1.5m) and 2016 levels (£1.25m) as below.  Over 101,000 people have open ‘Fixed Protection’ meaning that they are entitled to an LTA higher than the current figure of £1.03m.  More details on Fixed Protection can be found here: https://adviser.royallondon.com/technical-central/pensions/benefit-options/fixed-protection/

Source: HMRC FOI reply to Royal London