To protect or not to protect
Yet again, there is to be a diminution in the availability of reliefs and opportunities within pension planning for higher earners or those who have accrued significant pension savings. The latest cut in the pension lifetime allowance, from £1.5m to £1.25m from 6 April 2014, will therefore have a significant impact on retirement planning for wealthier clients.
It might not even end there as there is still a huge amount of political posturing going on around higher rate tax reliefs for pensions. It is entirely possible that the allowance will be frozen for the foreseeable future, or might even be reduced again.
This raises some difficult financial planning challenges for those affected and careful consideration of the protections and opportunities to maximise reliefs whilst they are available. HMRC estimate that 30,000 people will be immediately affected by this year’s cut to £1.25m, with 360,000 expected to break this limit over the longer term. And the risk that it won’t go up again soon means clients don’t even need to be particularly close to the £1.25m now to be affected by the cut over the coming years.
This table shows the current pension pot that will grow to £1.25M over various terms to retirement based on different growth rates:
So someone 10 years from retirement with a current pension pot of around £700,000 will exceed their allowance if their pot grows at 6% a year – even if they stop paying into it now. Yet it’s unlikely they’ll think they have a problem at this time. Of course, growth could be higher or lower than shown in the table – depending on the client’s investment strategy.
The two new options to lock-into a higher allowance, Fixed Protection 2014 and Individual Protection, while welcome, serve to complicate decision making for investors – decisions that many will not even realise are crucial to their future retirement planning strategy. Making the wrong decision could potentially expose up to £250,000 of their pension savings to a 55% tax charge. Think of this in a different way – an investor is looking at only 45% of the upside of any portfolio growth but still retaining 100% of portfolio losses on the downside due to this 55% potential tax charge.
There is much to consider before the tax year end. But the first step is for investors to identify if they are at risk.
Am I caught in the LTA net?
From 2014/15, the LTA will be lower than when it was introduced in 2006. This could radically change the retirement strategies used by wealthier investors, or even those who don’t yet view themselves as such.
It’s even trickier where defined benefits are concerned. Few people understand how valuable a Defined Benefit pension is – or how it’s tested against the LTA. Many would be surprised to learn, for example, that their £25,000 paid-up pension from a previous job already eats up £500,000 of their allowance. Adding early leaver revaluation up to retirement, at say 3.3% over 10 years, takes the pension up to £34,590 – using up almost £692,000 LTA.
The big decision
The LTA cut presents clients with some difficult choices before the new tax year, with one key question being to protect or not?
Which type of protection?
Getting it wrong could cost up to £137,500 in tax and the value of seeking professional advice becomes clear.
There are two new options to lock into a higher allowance:
Fixed protection 2014 allows clients to keep a £1.5m allowance beyond 2014. However pension savings have to stop after 5 April 2014.
Individual protection is only available to clients with pension savings worth more than £1.25m on 5 April 2014. It gives a personal allowance equal to the benefit value on 5 April 2014 (up to £1.5m).
And importantly it doesn’t mean giving up on pension saving
And aside from the fundamental ‘protect or not’ question, the potential need to cease, or cut back on, pension saving after April 2014, raises a host of other issues for investors, should they;
• Pay a final pension top-up before the shutters come down in April?
• Review investments to de-risk them and mitigate the 55% tax charge? (This can, unfortunately, lead to what can sounds like the nonsense of aiming to reduce investment returns to avoid taxation risk).
• Consolidate legacy pensions for easier policing of how much of the lifetime allowance you have used?
• Establish alternative (non-pension) tax wrappers for future savings (though these can, of course, carry more risk).
• Consider which strategies might be employed for wealth decumulation which may reduce the size of the pot.
• What is the most efficient way to transfer wealth to the family?
In short, there’s a lot to think about before 6th April 2014.