This article discusses the effects of the reduction in the Lifetime Allowance and the options available under pensions.
It has been well documented that the fall in the standard lifetime allowance (LTA) applying to registered pension schemes may cause people issues in terms of what to do with their current and future pensions in terms of the on-going funding and fund size. Various forms of protection have been introduced, but what if these are not applicable or correct for the client? In addition to this, HMRC have also introduced restrictions on pension funding for high earners, which will taper the annual allowance down to a minimum level of £10,000 (2016/17 tax year). The purpose of these articles is to discuss pensions and other options available for people who may be affected by the reduced lifetime allowance. This will cover both the investment and income alternatives to pension funding.
In many ways, much as these potential reductions could create an issue, it can also highlight the need for holistic financial planning to be used in this fast-changing financial and legislative environment.
This article is designed as an overview of what may be done and alternative options and is not designed to cover the full technical details. Other articles on Knowledge Direct will have more in depth details of items discussed in this article.
The points below lay out options and alternatives for pensions that can be considered and then, if relevant other Knowledge Direct articles on the specific subjects will go into more detail of the options, taxation and products mentioned.
- Fixed Protection (FP) – A client may have opted for either FP 2014 (£1.5 million) or going to opt for FP 2016 (£1.25) that gives them a standard LTA fixed at these higher rates. Applications for Fixed Protection 2014 had to have been made by the 5 April 2014 although there is no such deadline for the FP 2016.
Fixed protection gives a higher fixed lifetime allowance but an individual will no longer be able to have any relevant benefit accrual or make any contributions. This could be fine for those people who are possibly close to retirement and are near the LTA limit or for those who have a significant fund value and consider growth over the intervening years until retirement will exceed the new lower LTA.
- Individual Protection– this will be available for those individuals who, on 5 April 2014, have a pension fund valued at £1.25 million or more. This protection will protect the value of the pension funds the client has between £1.25 million and £1.5 million on 5 April 2014. This same style of protection is also available as IP2016 to protect funds between £1 million and £1.25 million on 5 April 2016. The client will be able to continue to make further pension contributions and accrue benefits but they will only receive protection on the fund value up to the individual protection they have received. Pension funds over this level will be subject to the lifetime allowance excess charge in the normal way. This protection may be of interest for those people who have a very large employer contribution and a small personal contribution. This may benefit them because even after the appropriate tax charge has been applied to the excess over their individual allowance, the remaining fund value from this excess is still much greater than the level of contributions they would have personally paid.
Example: a client funds £1,000 per year and the employer funds £9,000 per year for ten years. This will give a total of £100,000 which grows to £160,000 in this period. If all of this is classed as excess over their individually protected LTA and taken as a lump sum with a 55% tax charge, £88,000 will be paid in tax and the client will receive £72,000. However they will have only paid in £10,000 over this period to get this return – equivalent to a 720% return over 10 years.
- The client stops the pension contributions and has an agreement with his employer to enhance his salary. The cost of this to the client will be that they pay more tax on their salary and they will pay additional national insurance. The cost to the employer for the salary is reclaimable under corporation tax relief but the national insurance payments are not. This initially looks less inviting for both the client and the employer as they are paying tax at the front end. However, for people who have good pension funding but with employer and employee contributions of similar proportions, the option to use the opportunity of individual protection is less inviting and the option of having the additional salary may be considered with other investment options.
- The client uses a combination of individual protection and enhanced salary. There may be circumstances where the payment of additional contributions and additional salary can be used to help mitigate some of the tax charges for both the member and the company. This is an area that would require extensive discussions with an accountant to determine if there is a suitable compromise between these two events which would benefits the client.
As you can see from the above the options available to manipulate an individual pension within the rules for the new lower lifetime allowance are limited. In addition to the reductions to the lifetime allowance there have also been restrictions in the available annual allowances for high earners introduced. Tapered relief rules can restrict annual allowance limits down to £10,000 per year for individuals with adjusted income in excess of £210,000. If the individual is taking an income under flexible benefits they may also have a reduced annual allowance (Money Purchase Annual Allowance) and lose the ability to carry forward. There are articles on Knowledge Direct that cover these issues. Although many of these options will apply or be potentially applicable to clients, there will also be many circumstances where a little creative thinking would be potentially beneficial, utilising other alternatives to the member’s pension. These are discussed in part 2 of this article.