The high-earner tightrope: Don’t cut the cord!

Trustee duties for members with fixed or individual protection: The pitfalls for savers and trustees and how to avoid them

Members with fixed protection from the Lifetime Allowance are walking a tightrope and at the mercy of trustees and employers, whose actions could inadvertently cause these members to face additional tax charges of up to £165,000 (or £137,500 for fixed protection 2014).

Fixed protection and individual protection

High-earning members could apply before 6 April 2012 for fixed protection 2012, allowing them to retain a Lifetime Allowance of £1.8 million. Members applying for fixed protection 2014 will retain a Lifetime Allowance of £1.5 million after it reduces to £1.25 million on 6 April 2014.

Individual protection gives members a personalised Lifetime Allowance of the value of the member's benefits on 5 April 2014 (up to £1.5 million). Unlike fixed protection, individual protection allows continued benefit accrual in registered pension schemes after 5 April 2014 without losing the protection.

Individual protection 2014 can be combined with fixed protection, although those who already have enhanced or primary protection will be ineligible.

Fixed protection: potential pitfalls

There are significant restrictions for individuals with fixed protection. Fixed protection will be lost if the member:
• has further benefit accrual in a registered scheme – benefit accrual may be member or employer contributions to a defined contribution scheme, or accrual (above certain permitted levels of revaluation) in a defined benefit or cash balance scheme;
• joins a new pension scheme;
• makes transfers outside permitted criteria; or
• remains eligible for certain types of lump sum death benefit.

These restrictions are tested on an ongoing basis and fixed protection may be lost at any time, even inadvertently and without the member’s knowledge. Trustees should therefore think carefully before agreeing to changes to benefits or scheme mergers without considering the impact on members with fixed protection.

Trustee duties

It is good practice for trustees to let their members know about the potential benefits of fixed and individual protection and the relevant deadlines for applications (5 April 2014 for fixed protection 2014, with applications for individual protection commencing on 6 April 2014 for three years).

More importantly, trustees could be in breach of their duties if they take action which accidentally results in members losing fixed protection.

Trustees have a duty of care and skill for their members and a duty to look after their best financial interests. It is also a statutory requirement that trustees have knowledge and understanding of pension law. The Pensions Regulator's Scope Guidance on the TKU requirements makes clear this includes understanding the provisions of the Finance Act 2004 relating to the Lifetime Allowance. If trustees take a decision which results in a large tax charge for a member due to his loss of fixed protection, they may be open to challenge for breach of trust and breach of statutory duty.

Trustees might be able to rely on the scheme's indemnity and exoneration provisions. These will be construed strictly, however, and it would be better to avoid problems at the outset.

Key risk areas

To avoid breaching duties towards members with fixed protection, trustees should always consider the effect of their actions on these members. Members with fixed protection could be excluded from any changes that are detrimental to them or their consent could be sought in advance. Key areas where trustees should be mindful are:

• Auto-enrolment – trustees and/or employers should make fixed protection members aware that they have to opt out within the first month after being auto-enrolled to avoid losing fixed protection;
• Scheme mergers – where fixed protection members are transferred to a different pension scheme, their fixed protection will generally be lost (unless the merger is between two defined contribution schemes);
• Augmentations – augmenting benefits for all active and deferred members above the permitted level (generally, the inflationary increase in the scheme rules or CPI) may cause loss of fixed protection;
• Lump sum death benefits provided through a defined benefit scheme or registered life assurance scheme – if the benefit is limited to the proceeds of an underlying insurance policy, any premium payments or contributions made towards that policy will result in fixed protection being lost.

Written by Alex Anslow, Associate, Hogan Lovells International LLP

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