How to protect a big pension pot from the taxman

Time is running out for anyone wanting to protect large pensions. If the value of your pension entitlements exceeds the government's lifetime allowance, then you should apply for tax protection by 5 April this year, or you could be clobbered by a 55% tax charge.

When the Treasury introduced the lifetime limit the maximum pension entitlement that could be accumulated in 2006, it was set at £1.5m. That's risen to £1.65m for the current tax year ending 5 April 2009 and will rise to £1.75m in 2009-10, then £1.8m in 2010-11, before being frozen until at least 2015-16. Breaching those limits will prove costly taken as a lump sum, any amount above the limit is taxed at 55%, or 25% if taken as a pension via an annuity. That's on top of any other income tax levied. Now, £1.8m may sound a lot, but it can be exceeded easily enough by those with large money purchase pension funds. For example, says Gareth Jones of Sippdeal, someone with a pot which is £200,000 below the limit in 2010 would see their fund grow to more than £200,000 above it by 2016 with just 5% annual growth. That's not including further contributions.

So what to do? There are two options. There's 'primary protection', available to those with entitlements worth more than £1.5m at 6 April 2006, or 'A-day'. "Broadly this protects the value of all of your pension rights built up before 6 April," says Billy Mackay of pension provider AJ Bell. So if your rights were worth, say, £3m, you can enjoy them without being hit. What's more, your £3m can rise in future in line with the lifetime limit. So at 5 April 2006 it could have risen to £3.3m (1.65/1.5 x £3m) and still be exempt.

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Or there is 'enhanced protection', which protects "all of your pension rights from the lifetime allowance charge". It's available to those who do not currently have entitlements that exceed the limit but might in future thanks to, say, the growth of a money purchase plan's investments. It's well worth having, but there are strict conditions so seek advice to ensure you don't breach them. For example, those in defined benefit, or final salary schemes can only build up limited additional benefits after A-day to maintain the exemption. In all cases there is a special form to fill in[pdf] and submit to HMRC.