In his 2013 Budget, the Chancellor confirmed that the existing allowances for tax-free pension saving will be reduced from the 2014/15 tax year. The annual allowance – the yearly limit on pension savings permitted without triggering a tax charge – will be reduced from £50,000 to £40,000. The lifetime allowance – the total limit on tax-favourable pension savings permitted – will be reduced from £1.5 million to £1.25 million.

These reductions will lead to an increase in the number of individuals affected by the annual and lifetime allowances, particularly modestly paid employees with long periods of service in defined benefit pension schemes who may find themselves subject to annual allowance tax charges on their pension savings. It is also likely that trustees and employers will see an increase in queries from scheme members and an increased demand for “scheme pays”, which allows a member to require his pension scheme to pay the annual allowance tax charge arising in relation to his pension savings and make a corresponding adjustment to his scheme benefits.

Changes to the annual allowance

The amount tested against the annual allowance each tax year is the increase in the value of an individual’s pension savings over the pension input period (PIP) ending in that tax year. PIPs vary between pension arrangements and so if an individual belongs to more than one arrangement, he may have more than one PIP.

The use of PIPs to measure pension savings for the purpose of the annual allowance means that the reduction in the annual allowance to £40,000 may impact members before 6 April 2014. If, for example, a member’s PIP runs from 1 September 2013 to 31 August 2014, the reduced annual allowance will impact from 1 September 2013.

We understand that the existing carry-forward mechanism, which allows individuals to take advantage of unused annual allowance from the previous three years, will continue at the current level of £50,000 for tax years 2011/12 to 2013/14.

Changes to the lifetime allowance

As was the case when the lifetime allowance was introduced in 2006 and when it was reduced from £1.8 million to £1.5 million in 2012, transitional relief will be available for individuals who may be affected by the reduction in the lifetime allowance to £1.25 million with effect from 6 April 2014.

Transitional protection: fixed protection 2014

An individual who has not already claimed primary protection, enhanced protection or fixed protection (the 2006 and 2012 transitional protections) will be able to claim fixed protection 2014. The individual’s lifetime allowance will then be £1.5 million or the standard lifetime allowance if this subsequently exceeds £1.5 million.

As with fixed protection, once an individual claims fixed protection 2014 he will not be able to make any further pension savings. Those wishing to claim will be required to file a “paragraph 1 notice” with HMRC before 6 April 2014. Fixed protection 2014 is likely to be of benefit to individuals who think that the value of their pension savings is likely to grow beyond £1.25 million before their retirement, particularly those who are able to re-negotiate their remuneration package to replace employer contributions to a pension arrangement with alternative benefits.

Transitional protection: Individual protection 2014

HM Treasury and HMRC are currently consulting on a separate form of personalised protection for individuals with pension savings exceeding £1.25 million on 6 April 2014. An individual who has not already claimed enhanced or fixed protection can claim individual protection 2014 and will have a personalised lifetime allowance of the value of his pension savings at 6 April 2014, up to a maximum of £1.5 million. This will involve a valuation of the individual’s pension rights on 5 April 2014. If the standard lifetime allowance subsequently increases beyond the individual’s personalised lifetime allowance, the personalised allowance will revert to the standard allowance. Where the individual already has fixed protection or fixed protection 2014, the fixed protection will take precedence unless it is lost, when the individual will revert back to their personalised lifetime allowance.

Those with individual protection 2014 will be able to make further pension savings, though any savings over the personalised allowance will be subject to a tax charge. Individuals wishing to claim individual protection 2014 will be required to file a “paragraph 1 notice” with HMRC before 6 April 2017. Individual protection 2014 will be attractive to those who wish to continue pension savings post-5 April 2014 and are willing to pay a tax charge on their additional savings when these are taken. This might be particularly advantageous where an individual wishes to continue to enjoy the benefit of employer pension contributions where no alternative benefit is available.