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Auto-enrolment: directors and executives at risk of losing pension protection

Directors and senior executives are at risk of inadvertently losing protection on their pension savings by being auto-enrolled in their workplace pension scheme, according to wealth advisor Towry.

For those affected, there is the danger of their pension savings in excess of the lifetime allowance incurring a tax charge of up to 55%. This can affect not only those who have applied for fixed protection with effect from 6 April 2012, but also those who currently enjoy enhanced protection granted following the introduction of the lifetime allowance in April 2006.

On 6 April the Lifetime Allowance (LTA) will reduce from £1.8m to £1.5m. Individuals who have already made pension saving decisions based on the existing LTA can apply for 'fixed protection' so they retain the LTA of £1.8 million. However, to secure fixed protection they must notify HMRC in writing by 5 April 2012, and after that date, all future pension accrual must cease with no further contributions being paid into their pension.

The Lifetime Allowance was first introduced in April 2006 and at that time those potentially affected were able to opt for 'enhanced protection'. Enhanced protection fully protects an individual's pension savings from any future LTA tax charge, providing there has been no further pension accrual or pension contributions after April 2006.

Losing either of these forms of protection could be extremely costly. Whilst the loss of fixed protection could see a tax bill of up to £165,000 (55% of the difference between £1.8m and £1.5m) the loss of enhanced protection may be even higher, as all pension savings over £1.5 million will be taxed.

Auto-enrolment will mean all eligible workers being automatically enrolled into their employer's qualifying workplace pension scheme. This process starts from 1 October 2012 and employers must provide auto-enrolment for all eligible workers, and for all new workers when they become eligible.

An eligible worker is an employee aged between 22 and state pension age and earning above the income tax personal allowance (£7,475 in 2011/12). Contributions will be payable on earnings between £5,035 and £33,540. These limits are set to be reviewed before October 2012. Once enrolled, employees will have the option to opt out should they wish to do so. HMRC have confirmed that in order to maintain Fixed and enhanced protection, those affected must opt out within one month of being auto enrolled.

John Richardson, head of advice policy, advice:?"Fixed protection allows those who have based their pension savings on a lifetime allowance of £1.8 million to retain this limit, as long as they stop any pension accrual or contributions by 5 April 2012.

"But auto-enrolment could invalidate this protection unless prompt action is taken to opt out of their workplace pension scheme within one month of their auto enrolment. With firms having to re apply auto enrolment requirements to those who opt out every three years, these individuals will need to monitor this regularly. ?"Those with enhanced protection from 2006, whose pension savings are fully protected from the lifetime allowance, need to be similarly vigilant around the limits of their lifetime allowance. Unintended pension accrual arising from auto-enrolment could be a costly error for senior Directors that have built up the maximum pension fund."

According to Towry, HMRC recognised that auto-enrolment risks the loss of this valuable protection to Lifetime Allowance limits but have allowed those caught by it only one month to actively 'opt-out' to avoid inadvertent pension accrual.

"Directors will need to keep a close eye on their remuneration packages and their employer's auto-enrolment process if they are to avoid losing their pension protection and face a tax charge up to 55% of their pension savings in excess of the new reduced LTA of £1.5m," added Richardson.