People saving into a final-salary pension scheme who are receiving compensation for past discrimination may end up with big tax bills.
The law of unintended consequences strikes again. Pension schemes are warning that thousands of final-salary pension scheme members who thought they had protected themselves from punitive tax charges on their savings could be caught out by a High Court case that was supposed to compensate them for unfair treatment in the past. Savers risk 55% tax bills as a result.
The row follows last year’s High Court ruling over guaranteed minimum pensions (GMPs). Judges ruled that final-salary pension schemes had breached sex discrimination rules by allowing men and women to earn pension increases at different rates during the 1980s and 1990s. Schemes are being forced to compensate their members.
The compensation is a major headache for savers who have taken advantage of the fixed protection scheme. Fixed protection helps wealthy savers who already had large pension funds when the government introduced the lifetime allowance capping tax-free pension fund savings – and when it cut the allowance on subsequent occasions – but the compensation could undermine this protection.
Ordinarily, anyone with pension scheme savings worth more than the lifetime allowance (£1.05m in the current tax year) has to pay 55% income tax on the excess when they begin drawing down their benefits. But the fixed protection scheme effectively exempts savers from these charges if their pensions were already above the thresholds at the time they were introduced.
Crucially, savers taking advantage of fixed protection had to agree not to make any further payments into their pension schemes. Those who do invalidate their exemption from tax. Now, experts are warning that the compensation payments being made in relation to the GMPs case may count as an additional payment, triggering a substantial tax bill.
In the worst cases the payment of just a few pounds of GMP compensation could land a pension saver with a tax bill of several hundred thousand pounds. At least 100 pension schemes have suspended GMP compensation payments until HM Revenue & Customs issues advice on how to resolve the problem.
The scale of the problem is hard to gauge because HMRC does not publish data on how many people have used fixed protection. The scheme was first made available in 2012, but new versions were offered in 2014 and 2016.
However, pension experts believe significant numbers are likely to be at risk. High earners across the public and the private sectors are potentially vulnerable, assuming they began saving several decades ago when GMP rights were unfairly apportioned – and that they have applied for fixed protection more recently.