The new tax year usually brings several changes to pension planning.
This year is no different – even considering the fact that very few legislative developments have occurred in the past tax year with regards to pensions.
Lifetime allowance changes
When pension simplification came into effect on April 6 2006 (A-day), it introduced the concept of the lifetime allowance. The LTA was originally set at £1.5m, less than the benefits already accrued by some at either A-day or their planned retirement date.
In order not to disadvantage these people, the government introduced transitional protections that gave a higher or unlimited entitlement to the LTA.
We now have many variations on the LTA, ranging from £1.055m – the current standard – to the £1.8m applicable to those with fixed protection (from 2012). All of these different allowances will impact on the amount of benefits the member can take.
The LTA is scheduled to rise each year in line with the consumer prices index, although the actual amount is confirmed by the government on each occasion.
It will be 2025-26 or thereabouts before we see the LTA getting back close to £1.25m, and into the 2030s before we get near £1.5m. This is all dependent on the government not changing the rules, as well as CPI remaining around the 2.5 to 3 per cent level we are currently seeing. See Chart 1.
Although the LTA has only increased by £25,000, it will have an impact on the amount of charges payable. Assuming the excess over the allowance is taken as a lump sum, it could save a pension scheme member an immediate tax charge of £13,750 – or £6,250 if taken as taxed income. This isn’t an insignificant amount, and all tax savings should be welcomed.
Tax-free cash payments
The amount of tax-free cash (pension commencement lump sum) payable is dependent on the LTA that a pension scheme member has available to them. So the £25,000 increase means that most people will be entitled to an extra £6,250 tax-free cash.
For those that are higher or additional-rate taxpayers, this amount, while small, is still significant. However, it should be remembered that the maximum payable figure is still 25 per cent of the amount crystallised, so it will only be a benefit to those that are already at or near the standard LTA.
Protected tax-free cash
One of the big issues we often see in relation to the allowance change is the difference it can make to scheme-specific, tax-free cash. That relates to situations where an individual was in an occupational pension scheme before A-day, a position that entitled them to more than 25 per cent of the fund as tax-free cash.
This entitlement was because the way in which the cash was calculated in occupational schemes wasn’t related to the fund value. Instead, it was calculated based on salary earned and the time they worked for the relevant employer. That meant they could accrue a large proportion of cash in a scheme in comparison to their actual fund value. This cash was protected within the scheme at A-day.