In the famous and regularly quoted words of American politician and businessman Donald Rumsfeld: “There are known knowns; there are things we know we know. We also know there are known unknowns; that is to say we know there are some things we do not know. But there are also unknown unknowns; there are things we do not know we don’t know.”

So here we are in 2012 and the pension legislation landscape seems to be a little bit of all three. There is no sign that pension legislation will be the same at the end of the year as it is now. Some changes we know and some changes we don’t. One thing we do know, and a change that creates a pressing need for a lot of people, is the reduction in the standard lifetime allowance (SLA) from £1.8m to £1.5m from 6 April 2012.

The lifetime allowance was instigated on A-Day in April 2006 and in simple terms set a maximum tax relievable pension fund. It was originally set at £1.5m and had increased incrementally to £1.8m by 2011.

As part of an overall review into the future of pension tax relief and the distribution of that relief, it was announced in 2011 that the lifetime allowance would be cut to £1.5m and reviewed in five years. Now it would be easy to go off on a tangent here and discuss whether there is really a need for a lifetime allowance when we have an annual allowance or discuss whether the lifetime allowance is in effect just a tax on investment performance – but that probably requires separate discussion in its own right.

Just to confuse matters, and in the usual spirit of providing some form of transitional arrangements, we have had the introduction of the concept of fixed protection, which will allow individuals who opt for it to protect a pension fund of up to £1.8m even after the fal to £1.5m. The result of which is that there can be no future pension contributions to any type of registered pension scheme and no further benefit accrual in a defined benefit (DB) pension scheme. It is also important to note that any fund in excess of the lifetime allowance could be taxed at 55 per cent.

When thinking about the whole process of fixed protection it is important to note that applications must be made by 5 April, on the prescribed form (APSS227) and cannot be submitted online.

HMRC’s newsletter: ‘Fixed Protection Special Edition’ gives some good guidance about the procedure, but also shows how complicated the process can be. For example, it could be quite possible to lose fixed protection and not know that you have.

The key issues for me as I see them are the need to stop making further pension contributions and not being able to accrue further benefits. The contribution issue is fairly straight-forward, it could mean negotiation with employers over how remuneration is paid and whether it can be paid more tax efficiently in another way.

I have met some individuals who are in schemes funded solely by their employer who have said that any overfunding will not matter because even at a tax rate of 55 per cent tax they are still getting 45 per cent of something that they did not have before.

The issue with regard to benefit accrual is slightly more complicated. While it is relatively easy to stop contributions – in a similar way to those individuals who have enhanced protection – HMRC has said that that fixed protection is lost if at any time in a tax year the value of the member’s pension and lump sum rights are increased by an amount which exceeds the relevant percentage. The guidance mentioned above reiterates that this is an ongoing test.

The relevant percentage is defined in the regulations and for active members of DB schemes this will generally be 5.2 per cent in 2012/13, based on the consumer price index (CPI) figure for September 2011.

When looking at DB schemes it is important to include public sector schemes where individuals can have long service across a range of jobs in a particular profession. Included in this would be the NHS pension scheme, the teachers’ scheme and the university superannuation scheme, to name a few. In effect it is vital for senior and/or long serving members of such schemes to consider their pension position.

The first step is to value the final salary schemes in the prescribed manner against the lifetime allowance. The annual pension is multiplied by 20 and the value of any tax-free lump sum is added and then a decision can be made as to whether fixed protection is a real option.

Once valued there are some questions to be asked:

What is the current value? how is it likely to increase? will the benefit value get close to £1.5m or £1.8m?

Is there a target date of retirement? If it is before the normal retirement date under the scheme, will there be any actuarial reduction?

If the individual is an active member of the scheme, by how much do they expect their salary to increase over the next few years?

If the individual is a deferred member, what re-valuation will be applied to the deferred benefits and how is this comparable to an active member?

If an individual opts for fixed protection, it could be in an individual’s best interest to opt out of the scheme as any increase in accrual above CPI could revoke fixed protection.

At this current point in time, earnings are generally increasing at a lower rate than prices (that is, CPI) and this means that some scheme members can continue a degree of benefit accrual without exceeding the relevant percentage and therefore losing their fixed protection. Add to that a public sector pay freeze and, perhaps more by luck than judgement, the effect of benefit accrual in excess of the relevant percentage might be less common.

There are some difficult and complex decisions to make and the onus is placed on the individual.

Using the NHS scheme as an example, its information leaflet on the subject states: “Where a member has fixed protection NHS Pensions will not test benefits for benefit accrual. It is a member’s responsibility to test for benefit accrual, which can occur at any time during the tax year. If an individual remains an active member of a registered pension scheme HMRC have confirmed they may need to carry out the test more frequently than a deferred member who may test annually, when pensions increase is added to their benefits.

“Members should take professional advice on their own individual circumstances if they believe that remaining an active member of the NHS Pension Scheme could cause benefit accrual and a loss of fixed protection.

“Decisions about continuing in the NHS Pension Scheme, retirement or leaving the NHS Pension Scheme should be taken carefully; while tax is definitely one consideration, it is not the only one. NHS Pensions is unable to provide advice to members on whether they should consider fixed protection and members should consider taking professional financial advice on this matter before making a decision.”

If that was not enough, the scheme goes on to remind those concerned of the downside of not getting it right: “Where fixed protection is lost it is a member’s responsibility to notify HMRC of the loss within 90 days. If a member does not do this they will be liable to financial penalties.”

Is this an advice opportunity? Or is it a pension scandal waiting to happen? We will have to wait to find out. I have focused here on the NHS pension scheme, but in reality the principle applies to all DB pension schemes and particularly those with long service.

So not only could members of defined benefit pension schemes receive a tax bill if the value of any increased annual pension accrual exceeds the annual allowance (including any unused relief to be carried forward), but they could be forced to cease accruing further pension benefits.

This also creates a dilemma for the adviser. Even if you could show sufficient evidence, would you advise a senior individual to opt out of a final salary pension scheme? If you did, would you then advise a transfer? If so, can you justify it?

An individual with a large transfer value and a flexible lifestyle could well be a candidate for more flexible retirement options such a flexible drawdown. This facility is only likely to be available under a personal pension and would therefore require a transfer.

As I mentioned earlier in this article, the Lifetime Allowance is to be reviewed in five years and as such any decision made should be subject to regular review. It is quite easy to revoke fixed protection and this could always be an option. Pensions simplification – don’t you just love it?