A new interpretation of tax law by HMRC could see pensioner members of defined benefit (DB) pension schemes hit by unexpected tax charges if their scheme is bought out with an insurance company.

HMRC takes the view that the buyout of a DB scheme may not be a “permitted transfer” for pensioners with fixed protection and so could result in some members losing fixed protection.

Fixed protection provides members who have it with a lifetime allowance that is higher than the current standard allowance. However, thanks to a peculiarity in the relevant legislation, pensioners with fixed protection now risk losing that on buy out if they have other pensions that aren’t yet in payment.

When the lifetime allowance was first introduced, a number of protections were available for members who already had benefits in excess of that level or who expected their benefits to exceed that level.

Over time, the lifetime allowance was reduced and fixed protection was introduced in order to protect those who would be affected by those changes. Fixed protections were made available to following reductions in the lifetime allowance in 2012, 2014 and 2016.

The levels of fixed protection were set at £1.8m in 2012, £1.5m in 2014 and £1.25m in 2016.

Fixed protection is lost if there is any benefit accrual by the member or if there is a transfer which is not a “permitted transfer”.

Buying out a DB pension is widely regarded as being a positive thing for members and legislation is clear that certain protections are not affected by buyout.

Enhanced protection is unaffected, as is fixed protection for deferred members. What seems to be an anomaly in the legislation means the position for pensioner members with fixed protection is not clear.

HMRC takes the view that moving from buy-in to a buyout by the issue of individual policies from an insurer directly to individual members may not be a permitted transfer for pensioner members with fixed protection – so that the protection is lost.

Members who could be affected are those with pensions in payment in the scheme which is buying out, who have not used up all of their higher lifetime allowance and who have benefits in another scheme which are not yet in payment.

While schemes are likely to be able to identify some pensioners who have fixed protection, they may well not have this information for every member. The issue can affect members with small pensions if they have significant benefits in another scheme which have not come into payment. Some deferred members could also be caught if they decide to take their scheme pension during the buyout process.

Despite industry lobbying, a change in the law to bring the treatment of pensioner members with fixed protection clearly into line with other members seems unlikely to be on the cards in the near future.

Trustees, employers and insurers have therefore been forced to explore alternative ways to ensure that buyout activity can continue. One proposed solution is a two-stage process, which involves an individual policy for an affected member being issued to the trustees before being transferred to the member. That process seems to overcome the problem and may become more common.

Trustees who are considering a buyout process will need to consider with their advisers and their insurer how to address this issue. Trustees may well want to identify all those members who could be affected so they can explain the issue to them.

This could be a time consuming process involving more than one member communication so should be factored into buyout planning as soon as possible – early and clear engagement of all parties will be needed.

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