With the imminent increase in the lifetime allowance (LTA) from £1m to £1.03m, and hopefully future rises in sight, we need to consider the implications of what this means for the protections that members may hold.
The first increase in the LTA in six years isn’t much – at only £30,000 – but it could mean a lot to some people who are near the limit. In addition, future rises will mean much more and should not be discounted.
For those with the standard allowance, it could equate to £7,500 more in their pension commencement lump sum in the next tax year.
It would also mean £9,000 more in an individual’s pocket after tax if they draw the £30,000 out in one payment as a 40 per cent taxpayer.
A numbers game
It should be remembered that the LTA or, more importantly, the amount used up by an individual, is expressed as a percentage. This is so that the changes in the allowance over time can be easily dealt with by providers and members alike.
What it does mean is that for those that have used 100 per cent of their LTA, this is all irrelevant. Take for example someone who crystallises £1m today and has no LTA protection in place: they would have used 100 per cent of their allowance.
Come 6 April 2018 the LTA will have increased to £1.03m, but the member will have still used 100 per cent of their allowance and therefore won’t benefit from the increase.
This doesn’t mean that individuals should avoid crystallising all of their funds to leave a little LTA available to benefit from the increase.
If only 1 per cent is left this would have given them an extra £300, which is unlikely to be of any great benefit when you take into account some possible growth. What this does mean is that if the individual is looking to crystallise, then timing could be key.
If the client can wait a few extra days for their pension commencement lump sum, they could give themselves just a little more if they are just nudging over the standard LTA.
It isn’t likely to make a huge difference waiting a few days at the end of the tax year, and there is always the risk of a drop in fund value, but if the issue isn’t addressed then it could lead to a complaint later down the line. Understanding the impact is key to a good outcome.
2016 LTA protections
I am often asked if it is worth applying for the 2016 protections now that the LTA is on the increase.
There isn’t a definitive answer to this as it will depend on the circumstances of the individual, such as when they want to access their benefits, how much they could protect and how they want to access their funds.
What I would say is that having the information to apply should they want to at a later date is essential because we never know what will happen in the future.
There is no harm in applying for LTA protection because it will just fall away when the standard allowance exceeds the protected LTA.
Looking at Chart 1, it is clear that if the client were to have £1.25m protected through individual protection 2016 (IP16) or fixed protection 2016 (FP16) then it will still be many years before their personal LTA is exceeded, with this occurring in 2024-25, assuming CPI inflation remains at 3 per cent, or in 2026-27 if it were to drop to 2.5 per cent.
However, should the individual only have IP16 at a lower level, which could be anything above the current £1m LTA, it would be much sooner.
In some cases, IP16 will become invalid this coming tax year, so there would have been no point applying if nothing has yet been crystallised.
Other LTA protections
It is also clear from Chart 1 that it will be many years before the increase in the LTA has an impact on FP14, and even longer before the allowance reaches the dizzy heights of FP12, or more importantly the highest LTA we have seen to date.
By my estimates, at 3 per cent CPI inflation this would be another 19 years, or 23 years if we are looking at CPI inflation of 2.5 per cent.
I live in hope that we won’t see any significant changes in the plan to apply regular increases in the LTA between now and then – unless it is an ad hoc rise, which would be most welcome by the pensions industry as a whole.
There are still so many individuals that have been hit by the reduction solely due to great market performance.
It is just unfair that they are being penalised for investing well.
Claire Trott is head of pensions strategy at Technical Connection
