Beware of the compensation

Beware of the compensation

Photo by Marvin Esteve on Unsplash

It’s been reported recently that pension savers or retirees who were close to the lifetime allowance (LTA) at retirement or before could be pushed over due to certain pension compensation payments.  This follows a High Court ruling in 2018 stating that defined benefit pensions should be equal for employees in the same circumstances, irrespective of gender.

Three female members of the Lloyds Banking Group pension scheme brought a case against the bank, complaining that their pension incomes were increasing at a lower rate than those of their male counterparts.  This was due to the “guaranteed minimum pension” (GMP) rules.  GMP was accrued in defined benefit pension schemes when the scheme was contracted out of the state top-up pensions, such as the state earnings-related pension scheme (SERPS).

The court ruled that the scheme should treat male and female pensioners the same and it ordered that arrears be paid to members whose GMPs were not treated equally, with interest on back payments.  Lloyds was estimated as having to pay over £100m to members of its pension scheme and this has led to compensation for many women and men who work in the private sector.  Under GMP rules men’s and women’s GMP, depending when it was accrued, would need to be equalised by all schemes and compensation paid to those receiving pensions as well as those who have not yet taken benefits.  This affects members who were contracted out through defined benefit pensions between May 1990 and April 1997.

Fast forward two years and we find ourselves in a situation where trustees of defined benefit pension schemes are trying to calculate any compensation due and to find the best way to pay this to members, retirees and ex-members.  Most members due compensation will receive an uplift in their pension benefits, which is multiplied by 20 for testing against the LTA.  Full details of how benefits are calculated for the LTA can be found in our Guide to Pensions at https://www.bloomsburywealth.co.uk/guide-to-pension/

However, if you receive compensation in your final salary or defined benefit pension scheme, you could be faced with a LTA tax charge. 

Given that the current LTA is £1,073,100, this means (assuming that you have no other pension benefits) that if your defined benefit pension is £53,655pa or more, you may have to pay a LTA tax charge.  This seems like a large pension and it is but given that the LTA applies to all pension benefits including any funds which you have built up in other schemes, it is not as difficult as people think to breach the LTA. 

The issue we are now facing is that some pension savers who have already retired and whose benefits have either been valued at less than the LTA or paid a tax charge on any excess may now have to have their benefits recalculated due to the compensation.  This could lead to a LTA tax charge for someone who wouldn’t have had one or an increased charge for those who did.  This won’t be because they increased their pension savings without considering the LTA, but because they have received compensation for something they probably never even considered.

It could also cause problems for anyone nearing retirement who might have been planning on maximising their pension benefits within the LTA but now, following compensation, finds themselves being pushed over the limit.

There have also been fears that the compensation could affect those individuals who are relying on one of the forms of fixed protection against the LTA (again further information of the types of protection is included in our Guide to Pensions).  Under these forms of protection, an individual is not permitted to accrue any further benefits in pension schemes after the date of the particular fixed protection on which they are relying.  However, the compensation, which is not within their control, could be counted as additional accrual and invalidate their protection.  HMRC appears to have considered this and taken the sensible decision that the various fixed protections will not be lost due to the GMP compensation.  The ongoing issue here is that HMRC appears to have only clarified this for one method of compensation, which means that whether your fixed protection is safe or not can depend on how your specific pension scheme is providing the compensation.

One would hope that common sense prevails and HMRC provides clarification that all forms of LTA fixed protection will not be affected by any GMP equalisation compensation but there are no certainties.

Most pension schemes should be contacting members who are due compensation and if you think you might be affected, I suggest you contact a suitably qualified pension adviser or financial planner.

Cheers

Charles