Protecting clients’ lifetime allowances

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.

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.

Table A outlines various terms and investment returns and illustrates the current value of funds that will exceed the £1.25m limit.

Although Table A offers an indication as to which type of protection a client may choose, deciding which protection would best suit a client depends very much on their individual circumstances, including what point he is at in his career – ie, is he planning to retire soon and what is his investment strategy?

Table A

Clients who do opt for fixed protection must ensure they do not breach the relevant benefit accrual limits after 5 April 2014, so it is important for those currently receiving contributions from their employers to ascertain whether they would be compensated for no longer being members of pension schemes. The ease with which this can be done depends on the type of scheme of which the client is a member – it is far easier to do if the contribution for each individual is known, as it is with a defined contribution or money purchase scheme. But the compensation on offer may not necessarily equate to the pension benefit that the client is losing. Indeed, many may find that their clients would rather continue to pay into their pensions, as they would be financially better off, even having paid the tax charge.

There are numerous rules that, if breached, would result in a client losing fixed protection and this includes the fact that clients cannot start a new pension arrangement, such as being enrolled in an auto-enrolment scheme. Clients who have applied for fixed protection will have to opt out at the outset and every subsequent time they are opted back in to ensure they do not lose fixed protection.

Having said that, those clients who opt for fixed protection may wish to use the time before the new tax year to boost their savings and grow the value of their pensions towards the current £1.5m threshold.

For advisers with clients who are unlikely to receive any alternative remuneration from their employers if they opt out of their pension schemes, such as those who work for public sector bodies, individual protection could potentially be the solution.

As the deadline for fixed protection is looming it is important to first ascertain whether this would benefit a client. Indeed one of the points we have been keen to highlight to advisers is the fact that applying for fixed protection does not negate a client’s ability to apply for individual protection. There is no disadvantage to applying for both, assuming a client’s benefits exceed £1.25m on 5 April 2014. In these instances, fixed protection takes precedence and individual protection will only come into effect if fixed protection is lost.

With the new rules approaching, another conversation we expect advisers to have with clients whose funds are over the lifetime allowance, involves the best solutions for taking retirement incomes. If, for example, a client is £100,000 over the lifetime allowance, if he takes his pension as cash he would have to pay a 55 per cent tax charge and will end up with £45,000. A client who pays 40 per cent tax and chooses to use flexible drawdown would also end up with £45,000. However, if it is a client who has to pay the additional rate of tax, 45 per cent, they would end up with £41,250.

Table B compares how a client would be taxed on any benefits that exceed his lifetime allowance if he chose to take it as cash or as an income.

Table B

When the lifetime allowance was first introduced it was designed to go up not down and it is not clear whether we could see it lowered further in the future. One thing that is clear is that the changes afoot provide advisers with a genuine reason to contact their clients and demonstrate the value of advice pre, post and during retirement.

Steve Lewis is head of distribution of LV=