Protecting clients’ lifetime allowances

This article is part of
Annual Tax Planning - February 2014

At the start of the new tax year, the standard lifetime allowance for pension savers will be reduced for the second time since 2011, from £1.5m to £1.25m.

This change, which will come in from 6 April, means that if an individual’s pension benefits exceeds the new lifetime allowance a tax charge will apply on assets above the limit, unless they have previously been granted primary, enhanced or fixed protection.

A client would have to pay a charge of 55 per cent on a lump sum and 25 per cent if the fund is retained and taken as a taxable income. This means that those with pensions exceeding the lifetime allowance could be exposing up to £250,000 of their pension savings to a 55 per cent tax charge.

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The new rules will affect those with large accumulated funds and may well affect those with several generous pension schemes, with HMRC estimates indicating that the changes are set to affect around 30,000 people immediately. Furthermore, as many as 360,000 investors are expected to reach the new lower limit in the future.

To ease the transition to the new savings limit, HMRC has introduced two new protection regimes: fixed and individual protections. The proposed fixed protection rules will allow individuals to lock-in to a lifetime allowance of £1.5m provided they do not breach the benefit accrual rules by making further pension contributions, or, if they are in a defined benefit scheme, accruing excess benefits. To benefit from this regime investors will need to apply for the new protection before 6 April.

Under the individual protection regime, savers will be able to apply for a personalised lifetime allowance of up to £1.5m, based on the value of their pension pots at 5 April 2014. However, clients have three years to apply for individual protection from 6 April 2014.

Individual protection is still being consulted on, with the rules expected to be finalised this summer. What we do currently know is that those clients who opt for individual protection to protect the value of their pots will still be able to contribute to their pensions, but any benefit in excess of their personalised lifetime will be subject to lifetime allowance charges.

The deadline for fixed protection is just a few weeks away and in the past few weeks our team has spoken to hundreds of advisers looking to determine whether their clients are likely to be affected and to clarify which protection scheme would be most appropriate for clients.

While a £1.25m lifetime allowance may seem fairly generous it applies to an individual’s total pension worth. To ascertain whether a client needs protection, an adviser will not only have to look at the current value of their client’s private pensions and the growth projections, but will have to examine any workplace money purchase or defined benefit schemes their client may be a member of. While the majority of people that are expected to be affected in the first instance are likely to be workers in their 50s, many of the advisers we have spoken to are starting to speak to their younger clients with well-funded pensions who may require protection due to the fact that the future value of their pensions may exceed the new lifetime allowance.