Individual pension protection may make more financial sense for higher rate taxpayers than fixed option

11th June 2013


Insurer Skandia says well off investors may be better off taking individual protection on their pension rather than what is known as fixed protection under HMRC rules even if eventually it could be subject to a 55 per cent tax charge if taken as a lump sum in retirement. This is partly because taking fixed protection and receiving what would have been employer contributions as salary will also face a big tax hit.

New rules being proposed by HMRC will provide people with large pension savings the flexibility to continue to receive valuable employer contributions to their pension says Skandia.  It says higher and additional rate tax payers in particular may be better off receiving these pension contributions rather than receiving the benefit as additional salary, even though the future value of the additional pension contributions may exceed the Lifetime Allowance (and be subject to a 55% tax charge if taken as a lump sum in retirement).

The proposals are out to consultation and outlined in some detail by HMRC here.

The insurer has made the following calculations.

Individual protection and fixed protection have different rules as the following comparison highlights:

individual protection fixed protection
Can money purchase pension contributions continue? yes no
Can membership of final salary scheme continue? yes yes – but protection will be lost if any deemed benefit accrual arises post 6 April 2014
What will an individual’s lifetime allowance be? The value of the pension savings as at 5 April 2014  -which must be greater than £1.25m but subject to an overall maximum of £1.5m £1.5m max
Will it protect growth on those savings? no yes – up to £1.5m

Skandia adds that not being able to make money purchase pension contributions under fixed protection means there could be serious consequences in applying this form of protection. For some, ceasing to contribute to a pension scheme may mean they lose any lump sum death benefit, as well as any future employer contributions, it says.

Even if the employer agrees to pay the pension contribution to the employee as part of their salary instead, the tax and NI the employee will pay on the extra salary will leave them with significantly less to be able to personally invest outside of pension savings.  This could mean they end up in a worse position than if they had continued active membership of their pension scheme and suffered the 55% tax on the Lifetime Allowance (LTA) excess.

Skandia demonstrates the difference between £10,000 being paid into a pension and £10,000 being paid as extra salary assuming the individual is a higher rate tax payer in the table below:

Pension contribution continues to be paid by employer Pension contribution stopped and paid to employee instead Difference:
Gross payment by employer £10,000 £10,000
Personal tax 40% n/a -£4,000
Employer NI 13.8% n/a -£1,380
Employee NI 2% n/a -£200
TOTAL: £10,000 in pension £4,420 net pay £5,580 or 55.8%


* The example above assumes that the employer will fund the NI separately. This means the overall cost to the employer is £1,380 more than if they make the pension contribution.

Had the employer wished to keep the net cost of the employees remuneration package the same, then they would pay the employee £8,787.34 extra earnings, which would incur extra employer NI of £1,212.65 (total cost £10,000).

So, the example we use (below) assumes that the employee will get the equivalent pension contribution as earnings instead. This will result in a greater cost to the employer overall, as they are swallowing the extra employer NI on those additional earnings.

Using this basis, the employee could end up with 55.8% more as an initial investment through using their pension fund compared to receiving the equivalent net payment as salary. It highlights other factors including:

–          savings within a pension fund benefits from gross roll up

–          gains within a pension are not liable to capital gains tax

Adrian Walker, Skandia’s pension expert says: “The new individual protection offers an ideal underpin of security for those with at least £1.25m in their pension fund, without the downside of sacrificing pension contributions in the future. Fixed protection is a valuable option for those with significant savings to protect, but there are other key considerations that people will need to take into account, including the loss of employer contributions and possible loss of death in service benefits. If these are real issues, then people really need to think about what they are sacrificing, and whether they outweigh the additional 55% tax  liability that may be payable in the future.”

Obviously, if you are weighing up the two options, it may be advisable to seek independent advice about the decision.


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