Changes to the Pension Lifetime Allowance (LTA)

Changes to the Pension Lifetime Allowance (LTA)

For most clients of Green Financial - and that is who this blog post is for - , given the conversations we’ve had about your circumstances in the past, and your current pension status and value, I don’t think this should be a concern for you. The financial planning we have discussed means that the wider strategies I mention at the end of this document and the other tax efficient work we’ve been doing together should mean all is OK. However, if you’d like to discuss one of the pension protections, please contact me before the end of February.

Please do have a read of the following. Apologies for the length, if you’d rather call me, please do.

The headlines scream “Hundreds of thousands of pension savers in the UK risk being hit by hefty taxes as a result of the latest cut in the pension Lifetime Allowance (LTA). They are being urged to take urgent action to protect their pension pots, which are worth an estimated £250 billion.”

There’s no underestimating the importance of saving into a pension and for many of my clients, the amount they save will not reach the lifetime allowance. However for those who have contributed a significant amount towards their pension or are fortunate enough to have a defined benefit scheme (normally one or more old company final salary schemes) with a long service record could unknowingly discover they could be at risk of exceeding the LTA. In theory, failure to take out the necessary protection could lead to an unexpected tax bill of £137,500, although that does tend to be an alarmist worst case scenario figure for most people.

The LTA, introduced in 2006 as part of pension reform and simplification, is the limit on the amount of money an individual can save into their pension schemes before incurring a 55% tax charge.

When the allowance was introduced on ‘A Day’ (5 April 2006) the powers that be pledged to maintain its real value. This was the case until 2011 when the LTA peaked at £1.8 million. Since then, however there have been several changes to the allowance.

This April  (2014) the LTA will be cut to £1.25 million from the current level of £1.5 million. The powers that be say this will affect as many as 360,000 pension savers by the time they reach retirement. I just want to make sure you are not one of those 360,000.

As above, given the overall planning we are doing and your current pension/retirement income aims and status I don’t think you should have cause for concern but please contact me if you’d like to discuss or double check, especially if you have old pensions that I don't advise on or manage with you.

If you read further in this blogpost, you'll see there is more info on the LTA and the other things we do with financial planning that mean this probably won’t be an issue for you.

If you’d like to have a look at your own figures on a calculator, Standard Life, a pension provider have a web page:

http://www.standardlife.co.uk/1/site/uk/financial-education/tax-efficiency/lifetime-allowance-test

There are others, and your pension provider may have their own page - the one above is just pretty simple and quick to use, hence its inclusion here.

Or just contact me and I’ll do the projection with you / for you.

Further Info

Protecting your allowance

There are two new protection options for 2014, allowing pension savers to lock into the current, higher LTA of £1.5 million beyond 5 April 2014. These are known as ‘Fixed Protection 2014’ and ‘Individual Protection’. The best option for somebody might be to elect for either, both, or even neither. The optimum course of action will of course depend on your individual circumstances.

Fixed Protection 2014 allows pension savers to keep a £1.5 million LTA beyond 2014. This option is available to anyone who doesn’t have any of the earlier forms of protection (such as Enhanced, or Primary).

However there is a trade-off involved in securing this particular protection: Pension contributions to Defined Contribution (DC) schemes (such as your wrap SIPP) have to stop after 5 April 2014 while any increases in Defined Benefit rights can’t exceed a given ‘relevant percentage’ (normally CPI for the previous September) in any tax year.

The deadline for fixed protection applications is 5 April 2014.

Individual Protection is available only to people with pension savings worth more than £1.25 million on 5 April 2014. This gives individuals a personal LTA equal to their benefit value on 5 April 2014 (up to a maximum of £1.5m).

So someone with pension savings worth £1.36m on 5 April 2014 can lock-into a personal lifetime allowance of £1.36m. But someone with savings worth £1.55m would only secure a £1.5m allowance.

Crucially, this protection comes without the trade-off needed for fixed protection. Individuals in this category can keep funding their pension after April 2014 if they want to (or, perhaps more importantly, continue to enjoy pension funding from their employer). So, for individuals whose funds already exceed £1.5m by April, individual protection gives a better deal than fixed – a £1.5m LTA with no requirement to give up on future pension saving.

Smarter saving: wider strategies

I’ve long maintained that whilst pensions have benefits, there are also drawbacks. That’s why pensions have long been just one of the ways I help clients financial plan. If you are compelled to give up funding your pension as a condition of lifetime allowances you will likely still want to invest money somewhere. Luckily there is a wide choice of suitable alternative investment vehicles, and tax wrappers, available, many of which we already use.

Several strategies merit close consideration.

Use spouse’s pension: High net worth individuals should consider contributing to a pension for a spouse or civil partner. This is particularly valuable for a working spouse, as you can pay up to the higher of 100% of the spouse’s salary or £3,600 (less any contribution already being made by the spouse). The spouse will receive tax relief on the contribution. And the ‘gift’ will be covered by the spouse exemption for Inheritance Tax.

Maximise tax allowances: Realising capital gains on mutual funds on an annual basis ensures that you maximise the benefit of your annual exempt allowance for Capital Gains Tax (CGT) and the Income Tax Personal Allowance. If these are not used every year then they are lost and gone forever.

Utilise gaps in tax wrappers: If there are gaps in your use of tax wrappers, redirecting money that can no longer be saved in a pension could prove an ideal opportunity to address this.

Defer tax offshore: Tax deferred can mean tax saved. If you are a higher rate taxpayer now, it can be tax-efficient to invest through an offshore bond. You will not pay tax until funds are taken from the bond, allowing for planning such as taking gains when paying less tax in retirement, or assigning to a non-taxpayer.

Spread tax exposure: Diversifying your investments across assets that are subject to income tax and those that are primarily subject to capital gains tax puts you in a potentially better position to weather any variations.

For most clients, we include any of the above which are relevant in our general planning. Let me know if you’d like further info on any of them as it relates directly to you.

Please remember the usual regulatory warnings:

PLEASE don't take this blog post as personalised, specific, financial advice for you solely reading it - it isn't! - it's a generic blog post, with the aim of giving you a little info on some upcoming changes, which - if you are concerned affect your own situation - you can contact me or do further research yourself.

The value of investments can go up or down and may be less than what was paid in. Returns are dependent on investment performance and are therefore not guaranteed.

Tax rules and legislation can change and any information given is based on our understanding of law and current HM Revenue and Customs practice