Is it all PIE in the sky? Part 2: Lifetime Allowance

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FRI, 20 DEC 2019

A pension increase exchange (PIE) is where an individual is offered a one off higher scheme pension with no further non-statutory increases. The acceptance of a PIE by the member may not always be straightforward, as intimated in my previous article on its potential impact on the annual allowance. In this second article, I consider another area where there could be consequences; the lifetime allowance (LTA).

In a simple scenario, at the point of retirement, the individual receiving an increase in their pension as a result of a PIE will have a higher initial pension. This just means a larger amount of the individual’s LTA is used at the relevant benefit crystallisation event (BCE). This is due to the methodology of determining the capital value of the BCE, which is to multiply the initial annual pension payable by a factor, usually 20; the higher initial pension therefore results in a greater percentage used of their LTA.

Where the individual is a pension member of the scheme and they are offered a PIE, then there is a possibility of a BCE 3, and if this were to occur, then a further amount of the individual’s LTA would be used. However, the likelihood of a BCE 3 happening is, in my opinion, highly unlikely due to what are termed the “excepted circumstances” rule/guidance. The flexibility these rules afford suggest that the possibility of a BCE 3 is remote.

While the PIE LTA usage is relatively straightforward, things get slightly more complicated where the individual has certain forms of LTA protection. The relevant forms of protection where it may have a bearing are enhanced protection and any of the variants of fixed protection. The reason for this is that if benefit accrual is deemed to have occurred under any of these forms of protection, the individual may lose their protection.

Where the individual is a member of a defined benefit (DB) arrangement there are different criteria for benefit accrual, depending on whether the individual holds enhanced protection or fixed protection. For enhanced protection it is an output test, and the test to determine whether any benefit accrual has occurred is done either at the point of a BCE or where a permitted transfer to an other money purchase arrangement occurs. If, at either, the value of the individual’s rights is more than what is termed the “appropriate limit”, then benefit accrual has occurred, and enhanced protection is lost.

In the case of a PIE accepted pre-retirement, the test would only be carried out when the individual took their benefits, or on a pre-retirement transfer to an other money purchase arrangement, and not at the time of the offer. A PIE at retirement results in the test at that point, and if the PIE was post retirement it would only be an issue where there was BCE 3, bearing in mind my previous comments about a BCE 3.

The impact of the loss of enhanced protection ultimately depends on the circumstances. Pre-retirement it could be significant, post-retirement perhaps less so, unless the individual also held money purchase arrangements, as there could be associated BCEs that result in an LTA charge.

With fixed protection, benefit accrual is an ongoing test and protection will be lost if the individual’s benefits increase beyond a “relevant percentage”, though only on their prospective rights. This protection can therefore only be lost prior to taking their benefits from the scheme. Whether the individual is an active member, or a deferred member, a PIE is likely to result in them losing their fixed protection.

Commonly, where a PIE is offered, it is a case of weighing up whether the higher-level pension is worth more than an increasing pension longer term. The ‘right’ answer will depend on personal circumstances such as retirement plans, life expectancy, and tax position. The retiree may, for instance, wish to travel extensively in the early years of retirement and so opt for the higher initial income. However, in a small number of cases, as outlined in the articles, other factors may have a bearing, and accepting the PIE could have serious implications for those individuals.

As with much of pension tax legislation, knowledge of the detail is critical, and if a PIE is offered to an individual it is unlikely, they will personally have enough grasp of the appropriate legislation. In such circumstances, it is important that they seek financial advice before making a decision they could subsequently regret.

This article first appeared on Money Marketing

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