Changes to the lifetime allowance (LTA) and annual allowance (AA) for pensions are due to take place from 6 April 2014.
As a result, many advisers are starting to look at the pension position of some of their clients.
With the changes come new forms of protection, namely ‘fixed protection 2014’ and ‘individual protection’.
Fixed protection will allow an LTA of £1.5m and can be applied for by anyone not already holding protection – on the condition that contributions and accrual cease.
Individual protection is only available to those with a fund value of between £1.25m and £1.5m on 6 April 2014, but it has the flexibility of allowing a top-up to the protected LTA should the value of the pension have slipped from this amount by the time the fund is crystallised.
Getting it right could mean an LTA of £1.5m, and with no protection the difference could well be a tax charge of 55 per cent on £250,000.
Case studies: should these clients apply for protection?
Financial adviser Peter is looking into the cases of two clients: Charles and Alex.
Charles is a 45-year-old accountant, his fund value is currently £500,000 and he wants to retire at 65. He only has to achieve 4.5 per cent per annum investment return and, all things being equal, he would get close to an LTA of £1.25m.
Alex is the managing director of a small IT company. He has a small self-administered scheme (Ssas) worth £400,000, which was set up to buy a commercial property that is receiving £20,000 per annum rent on an upward-only rent review. Looking ahead to retirement in 18 years, the rent together with just a 3.5 per cent per annum investment return would result in a fund value of about £1.25m.
Neither client is eligible for individual protection, as their current fund values are nowhere near £1.25m. So, should Peter advise his clients to apply for fixed protection?
A reasonably achievable investment return would appear to get there, but with this Peter is concerned about a number of issues:
1. By applying for fixed protection, contributions will have to immediately cease – there is a bit of a leap of faith for both clients that their fund value will reach the LTA by relying on the assumed growth rate without supporting it with further contributions.
2. Conceptually, it might be difficult to advise a high-risk investor to maintain a low-risk portfolio.
3. In both cases the required return is not overly high, but a missed year or two could leave a shortfall in fund value, or a higher return could incur a significant tax charge.
4. In Alex’s case there is an upward-only rent review in the lease of the commercial property, meaning that rent will increase and so, potentially, the LTA position could worsen and need to be actively managed.
5. There is no real allowance for any inflation in the period to retirement.
6. There is no certainty as to what is going to happen to the LTA in the future – it is not indexed and, if left alone, the value will be seriously eroded by inflation and/or falling annuity rates/Gad rates.
7. Peter was looking to advise Alex about an auto-enrolment strategy for his employees, but it did not feel quite right to be talking about the importance of pensions for his employees and at the same time tell him that he has to cease paying contributions himself.
Peter also had a concern about some of the wider advice issues for these two clients. The investment returns were quite low and therefore the implications of ceasing payment were less if the investment return was achieved. But what about a higher rate of return of, say, 7 or 8 per cent or more?
Ceasing payment of contributions and not meeting the return would create an even greater downside and could even lead to a revocation of fixed protection in order to pay contributions back to an LTA of £1.25m.
In reality, the LTA is extremely likely to change again and it seems that the only way is down – this is an important decision to get right first time.
Mike Morrison is head of platform marketing at AJ Bell.
