12,000 savers face huge tax bills over loss of lifetime allowance protection

•        Significant spike in breaches of LTA protections since auto enrolment began
•        Court ruling offers hope for accidental breaches

Thousands of pension savers have breached lifetime allowance ‘protections’ in the past 12 years, potentially landing themselves with tax bills running into hundreds of thousands of pounds.

An AJ Bell Freedom of Information request reveals over 12,000 investors have notified HMRC they have lost one of the various forms of lifetime allowance protection introduced since ‘A-Day’ in 2006 (see table below). 

This is when the modern system of pension tax allowances was introduced as part of a radical simplification programme under Tony Blair’s Labour Government. 

Each time the lifetime allowance has been cut since A-Day, a new set of transitional protection rules has been created. 

There are four types of protection which can be lost when a member contributes to a pension scheme: enhanced protection, fixed protection (2012), fixed protection (2014) and fixed protection (2016).

Tom Selby, senior analyst at AJ Bell, comments: 

“The lifetime allowance is a pernicious tax which effectively punishes defined contribution savers who enjoy strong investment performance. 

“Furthermore, successive cuts to the allowance in recent years have created a complex web of protections designed to protect people close to the lifetime limit from being unfairly penalised.

“A number of these protections come with terms and conditions – namely that you are no longer allowed to contribute to a pension scheme. If you do, the protection is lost and you could face a huge tax bill on the excess.

“For example, someone with a £1.25 million fund who took out fixed protection 2016 and subsequently lost it in the 2018/19 tax year would face a tax bill of £121,000 on the excess.”

Hope for those who accidentally contributed?

“While we don’t know the exact reasons for all of the protection breaches, around 7,000 have been recorded since the introduction of automatic enrolment. We have seen a particular spike since 2017, coinciding with the roll-out of the reforms to smaller businesses.

“It is likely a significant proportion of these people accidentally broke the terms of their protection by failing to opt-out of their workplace scheme, either initially or at their re-enrolment date three years later. For these people the massive resulting tax bill will be a bitter pill to swallow.

“However, in a recent First-tier Tribunal ruling the judge decided a man who had accidentally voided his lifetime allowance fixed protection by failing to cancel a contribution standing order should have the protection reinstated. 

“If HMRC is unable to get the ruling overturned at appeal, it may mean thousands of pension savers who have had their protection certificate revoked are knocking on its door asking for their money back.”  

Where do we go from here?
“Whether it is doctors being hit with tax bills for breaching the annual allowance taper or savers losing fixed protection after contributing to a pension, it’s clear the inherent complexity of the pensions system is causing problems for higher earners. 
“The Government should review the pension tax regime and consider simpler alternatives which don’t unnecessarily hamper those doing the right thing and saving for retirement. 
“One option would be to create separate tax regimes, with defined benefit schemes controlled by a lifetime allowance and defined contribution by a single annual allowance. This would allow the Treasury to keep a lid on costs and in the process remove huge complexity from the system. 
“The annual allowance taper and money purchase annual allowance could then be scrapped altogether, radically simplifying the system in the process.”

Lifetime allowance protection breaches since 2007

Source: HMRC Freedom of Information request        
*Totals exclude years where fewer than 10 breaches were reported