TECHTALK
This article originally appeared in SEP 15 edition of techtalk. Please visit www.scottishwidows.co.uk/techtalk for the latest issue.
LIFETIME
ALLOWANCE
PROTECTION –
READY FOR
ANOTHER ROUND?
Chris Jones
The lifetime allowance reduces again from
6 April 2016 to £1m, accompanied by another
round of protection. A further reduction means
many more clients will be affected and in need
of advice. We look at the options available.
Whilst at the time of writing we don’t have the technical
details, HMRC pension schemes newsletter 70 confirmed
that there will be the same options as in 2014 with the same
conditions. The only difference will be the application process
and deadlines which are yet to be decided, however, there is
a suggestion that the time limits may be removed altogether.
Depending on the value of their funds as at 5 April 2016,
clients have up to five choices, Individual Protection 2016,
Fixed Protection 2016, both forms of protection, or no
protection. In addition, clients over their minimum retirement
age could also consider the option of crystallising benefits
before 6 April 2016.
Let’s start with an overview of the two protection options we
expect to be available.
For professional adviser use only, not to be relied upon by any other person.
FIXED PROTECTION 2016 (FP2016)
• Offers a protected lifetime allowance (LTA) of £1.25m
• No minimum fund value requirement
• Money purchase contributions must cease by 5 April 2016
• Final salary allows limited accrual based on CPI
increases or potentially other increases covered in
scheme rules
• Not available to those with Primary or Enhanced
Protection
• Await confirmation of the application window. It is
• For pre A-day pensions or annuities with no post A-Day
crystallisation events the value is 25 X the pension in
payment at April 2016
• Pre A-day drawdown with no post A-Day crystallisation
events 25 X the 120% of maximum drawdown (as if it
were capped) in the drawdown year including April 2016
• Crystallised rights will be valued at the amount tested
against the lifetime allowance, re-valued in accordance
with any changes to the limit.
Once you have worked out the value of a client’s benefits you
can then consider the options available.
possible that there will be no application deadline at all.
INDIVIDUAL PROTECTION 2016 (IP2016)
• IP2016 will be available to those with funds valued
at £1m or more as at 5 April 2016
• Protects the value of the fund at 5 April 2016 up to
a maximum of £1.25m
• Contributions and/or benefit accrual can continue
• Not open to those with Primary Protection
CLIENTS WITH LESS THAN £1M
Those that fall into this category have two choices; no
protection or Fixed Protection 2016.
Where there are no employer contributions then
straightforward projections of future benefits to the expected
retirement date will provide a useful guide to making a
decision. Both the term to retirement and the assumed growth
rates will make substantial differences to the outcome.
• Potentially no time limits on application
Whilst there may be no time restrictions in applying for
the latest rounds of protection, the requirement to cease
accrual under FP2016 and the valuation requirements as at
5 April 2016 for IP2016, mean that this shouldn’t make any
difference to the advice considerations.
“DEPENDING ON THE
VALUE OF THEIR
FUNDS AS AT
5 APRIL 2016,
CLIENTS HAVE UP
TO FIVE CHOICES”
VALUATION OF BENEFITS
The valuation of the client’s current accrued benefits is the
first important step in advising clients, as this will indicate
what options are open to them and which type of protection,
if any, should be considered.
In summary benefits are valued as follows:
• For money purchase schemes it is simply the value
of the fund
• For defined benefit schemes, it is the value of accrued
pension X 20 plus any tax free cash (unless paid by
commutation of the pension)
EXAMPLES
A client has a fund of £700,000 with 5 years to
retirement. With an assumed growth rate of 5% after
all charges, the projected fund value would be
£893,397. This may indicate that fixed protection is
not required and there may be scope for further
contributions.
If however, the same client has 10 years to retirement,
using the same growth rate assumption they would have
£1,140,226 meaning that FP2016 may be of benefit.
Taking a more cautious view and assuming a growth
rate of 3.5% a year, the same fund would only be worth
£987,419. In this case the numbers would indicate
FP2016 isn’t required.
The closer to retirement the client is the easier it will be to
make the decision as you are less reliant on the assumptions
proving accurate.
Where there are no employer contributions and there is any
likelihood that FP2016 will be of benefit then the safest
option may be to rely on FP2016 and wait and see. They can
then ‘revoke’ FP2016 if further contributions will be of
benefit in future years.
Where there are employer contributions the decision is more
difficult. If there is no alternative benefit on offer from the
employer, then a taxed benefit is usually better than no
benefit. However, it is possible that the effective rate of tax
on the contribution is greater than 100%. In this case
stopping contributions or benefit accrual and applying for
protection may be the better option. More complex projections
may be required to provide guidance. These could be similar
to our examples in the section on funds between £1m and
£1.25m below.
CRYSTALLISE BEFORE THE
REDUCTION
Clients who have reached their minimum retirement
age also have the option to crystallise benefits by
5 April 2016. This may be a better option for many as
it effectively gives them a higher lifetime allowance
and allows them to make further contributions.
For example, a client aged 57 has built up a fund value
of £850,000. If they crystallise by 5 April 2016 this
will use up 68% of the LTA (£850,000/£1,250,000).
This leaves them with 32% ie another £320,000 for
further funding under the reduced lifetime allowance
rather than £150,000 if they did nothing.
Of course to achieve this they would need to withdraw
the 25% tax free cash from the pension fund, however,
the option of further funding may make this a more
attractive option than simply applying for FP2016. Any
exit penalties or guarantees on the current pension
fund should also be considered.
CLIENTS WITH MORE THAN £1.25M
Where the fund is worth more than £1.25m the decision in
most cases is fairly straightforward. FP2016 is no better than
IP2016 in this scenario. Clients can rely on IP2016 and retain
the option to make further contributions later, if for example
fund values fall.
With the previous round of protection, one potential issue
with Individual Protection were pension sharing orders
as pension debits reduced the relevant amount for IP2014
purposes. We will await further details in the technical
guidance to see how these will be treated this time.
CLIENTS WITH FUNDS VALUED BETWEEN
£1M AND £1.25M
This is where the decision can become more difficult.
However, as before it can be more straightforward if there
are no employer contributions to consider. In this case
using both forms of protection is probably the obvious and
easiest choice. This allows clients to adopt a ‘wait and see’
approach. If the fund grows clients can rely on FP2016.
If it drops they can ‘revoke’ FP2016, rely on IP2016 and make
further contributions.
For many clients in this bracket the decision won’t be so
simple. This can arise where there are employer contributions
and employees have no discretion as to how they are
rewarded, for example many senior public sector workers.
As with clients with less than £1m, projections comparing
FP2016 and IP2016 can help guide the decision.
EXAMPLES – FP 2016 AND IP 2016
COMPARED
The projections below compare FP2016 with IP2016 over two
different terms. Where IP2016 is used, employer contributions
can continue. Where FP2016 is relied upon, contributions
must cease. To keep this simple, we are using money purchase
contributions but the same principles will apply for defined
benefit schemes.
ASSUMPTIONS
Current fund value £1.125m (half way between £1.25m and £1m)
Employer contributions of £25,000 per year in advance
under IP2016
No contributions with FP 2016
Average investment growth of 5% pa compound after charges
LTA charge of 55% on excess over protected lifetime allowance
Table 1 shows 3 years to retirement
Table 2 shows 8 years to retirement
Table 1
£1,125,000 initial value
Projected fund value
Projected value of
contributions
Total fund
Excess over LTA
LTA charge
Benefit after charge
3 years until retirement
FP2016
IP2016
£1,302,328
£1,302,328
£0
£82,753
£1,302,328
£1,385,081
£52,328
£260,081
£28,780
£143,044
£1,273,548
£1,242,037
Value of additional
contributions
Outcome
-£31,511
Fixed Protection would
be better
Table 1 shows that applying for IP2016 and continuing with
employer contributions can produce a worse outcome than
if contributions cease and the client instead applied for
FP2016. This is because the protected growth on the fund
is worth more than the value of the employer contributions
which are subject to the LTA charge.
Table 2
£1,125,000 initial value
8 years until retirement
FP2016
IP2016
£1,662,137
£1,662,137
£0
£250,664
£1,662,137
£1,912,801
Excess over LTA
£412,137
£787,801
LTA charge
£226,675
£433,290
£1,435,462
£1,479,511
Projected fund value
Projected value of
contributions
Total fund
Benefit after charge
Value of additional
contributions
Outcome
£44,049
Individual Protection would
be better
In table 2 we have the same scenario but over a longer term.
In this example a smaller proportion of the growth on the
fund is protected and the employer contributions are more
significant meaning that individual protection produces a
better outcome.
As before, the growth assumptions will also make a significant
difference to the projected outcomes. Any projections can
only provide a guide and each client will need individual
advice based on their personal situation.
Clients in this category who have reached their minimum
retirement age should also consider the option of crystallising
funds before 6 April 2016 as described above in the section
on clients below £1m.
MAXIMISING CONTRIBUTIONS
Any decision about LTA protection may also involve ensuring
contributions are maximised by 5 April 2016 using any carry
forward allowance from the previous three tax years plus any
available annual allowance for the post alignment period in
2015/2016.
Clients applying for either FP2016 or IP2016 may want to
consider this. For those applying for FP2016 it will be their
last opportunity to contribute. For those applying for IP2016
contributions will increase their fund value allowing them
to protect a higher amount.
KEY FACTORS IN THE DECISION
VALUE OF BENEFITS AT 5 APRIL 2016
The value will determine which protection options are
available. Clearly individual protection will be of greater
benefit the closer the initial fund value is to £1.25m.
EMPLOYER CONTRIBUTIONS/CONTROL
OF REMUNERATION PACKAGE
As we have seen above, where there are no employer
contributions the decision is relatively more straightforward.
Where employer contributions can be controlled or redirected,
the choice is also easier.
However, clients with no control or choice over employer
contribution will be the most complex to advise. They may
have to face the difficult decision to give up what seem like
valuable benefits in order to protect the benefits built up so
far. Individual Protection aims to prevent this to an extent
but as we have seen it can still produce a worse outcome than
giving up contributions entirely and applying for Fixed
Protection.
The key factors above are all interlinked. The only way to
make a sensible choice is to consider all of them in terms of
the specific client’s individual situation. This is an area where
clients really can benefit from personal financial advice.
PENSION TAXATION CONSULTATION
Another factor in the decision is the government’s
consultation on the taxation of pensions. It is possible that
the whole regime may have changed by the time the new
protection comes into place making advice even more
difficult The suggestion that application deadlines will be
removed or extended will help, however, those relying on
FP 16 will still need to cease contributions/accrual on
5 April 2016 so hopefully we will have a clearer idea of any
changes before then.
AGE/LENGTH OF TIME TO RETIREMENT
The longer the term the more difficult it will be to predict
which option will produce the best outcome. For those closer
to retirement it is also important to remember that early
retirement adjustments or tax free cash commutations could
mean that clients with notional funds greater than £1m
may find that there is no issue when they actually take
benefits.
ATTITUDE TO RISK/EXPECTED
INVESTMENT RETURNS
The expected or projected investment returns will have a big
influence on any decision.
Every care has been taken to ensure that this information is correct and in accordance with our understanding of the law and HM Revenue & Customs practice, which may change.
However, independent confirmation should be obtained before acting or refraining from acting in reliance upon the information given.
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