Your five-minute guide to the pension lifetime allowance reduction
The maximum amount you can save into pensions over your lifetime (without triggering extra tax) reduced in 2016. Find out how this may have affected you – and what you can do about it – from Michael Roberts, a Chartered Financial Planner.
Since 6 April 2016, the lifetime allowance for pensions has reduced from £1.25m to £1m. This may still sound like a very generous allowance – but it can be surprisingly easy to breach.
So what exactly is the lifetime allowance (LTA)? In essence, it caps the amount you can withdraw from pension funds without triggering an extra tax charge. Any pensions funds above this amount will be subject to a Lifetime Allowance Charge.
This is not the first time the LTA has been reduced. In April 2012 we saw it drop from £1.8m to £1.5m, followed by a further reduction in 2014 to the current level. The good news, however, is that there will be two forms of transitional protection available if you happen to be affected by this reduction.
How do I know if I am affected?
If you have only money purchase pensions (as opposed to a final salary pension), it is simply a matter of determining whether your pension fund is likely to be valued in excess of £1m by the time you draw benefits (although you also need to consider any pension benefits you have previously begun to draw). You will need to take into account the likely fund growth and future level of pension contributions, but an adviser can do that for you.
However, if you have benefits within a final salary pension scheme (either deferred entitlement or benefits you are still accruing) things can get more complicated. These types of pension benefits are valued by multiplying your pension entitlement by a factor of 20. If you are entitled to a lump sum in addition to the pension, you’ll need to add this too.
How it works: Craig’s pension
Craig was a member of a final salary pension scheme which he left several years ago when his employer closed the scheme. His entitlement from this scheme is a pension of £45,882 per year, plus a tax free cash sum of £305,882. Since Craig’s employer closed the final salary scheme, they have been paying into a personal pension for Craig, which is currently valued at £250,000. His benefits for LTA purposes are therefore valued as follows:
45,882 x 20 = 917,640
917,640 + 305,882 = £1,223,522
1,223,522 + 250,000 = £1,473,522 total pension value
As Craig’s total pension benefit value is in excess of £1m, he will be affected by the reduction in the LTA. Even if his current benefits had been worth less, he may still be affected as a result of the growth in benefits between now and retirement.
What are the transitional protection arrangements? Could these help me?
There are two types of transitional protection available: Fixed Protection 2016 and Individual Protection 2016.
Fixed Protection 2016 (FP2016)
FP2016 is available to anyone regardless of the current value of their pension benefits. In simple terms, a successful application for FP2016 will mean you can retain the LTA at its current level of £1.25m, and this is the LTA your pension benefits will be tested against, rather than the new, lower allowance of £1m. For some individuals, this may solve the problem.
Please note, however, that FP2016 will be lost if you build up future pension benefit, either by way of further contributions to a money purchase scheme or benefit accrual in a final salary scheme (having said that, there is an easement that allows a certain level of accrual within a final salary scheme). But you will need to take care that you are not automatically enrolled into a workplace pension by your employer.
You can’t apply for Fixed Protection before 6 April 2016. Also it’s vital to make sure you don’t accrue any pension benefits after 5 April 2016, as this would mean you cannot apply for FP2016.
Individual Protection 2016 (IP2016)
IP2016 is only available to you if your pension benefits are valued in excess of the new LTA of £1m on 5 April 2016. A successful application for IP2016 will give you a Personalised Lifetime Allowance (PLA), based on the value of your pension benefits and capped at £1.25m. For example, if your pension benefits are valued at £1.15m, your PLA will be £1.15m. If your benefits are valued at £1.25m or above, your PLA will be £1.25m.
The benefit of IP2016 is that you may continue to accrue pension benefits after 5 April 2016. You should think hard about whether this is a good idea in your circumstances, as any future benefits accrued could be subject to a Lifetime Allowance Charge (see below).
Individual Protection 2014 (IP2014)
Although this type of protection relates to the previous reduction in the LTA which came into effect in 2014, you can still apply for this type of protection until 2017. This may be preferable depending upon the value of your pension benefits on 5 April 2014.
What if I previously applied for transitional protection when the rules changed several years ago?
If you have previously applied for Enhanced or Primary Protection, Fixed Protection 2012, Fixed Protection 2014 or Individual Protection 2014, you should seek advice on how to proceed. The position is complicated and the most suitable outcome for you will depend upon your individual circumstances.
What are the consequences of exceeding the LTA?
As mentioned above, a tax charge (known as the Lifetime Allowance Charge) is levied upon benefits in excess of the LTA. The amount of the charge depends on how the excess benefits are drawn; if taken as a lump sum, the charge is 55 per cent, or 25 per cent if the benefits are used to provide a pension income (although this pension income will also be subject to income tax in the usual way).
What should I do if I think I am affected by the LTA reduction?
If you think you will be affected, advice as soon as possible. There is no blanket solution for those who are affected by the change, as it very much depends upon your personal circumstances.
How do I apply for FP2016 or IP2016 Transitional Protection?
HMRC is introducing a new online application process for FP2016 and IP2016, available from July 2016. You will still need to make a full application once the online application process is available, to ensure your pension benefits remain protected.
What should I do now?
The LTA is a complex area, and the right solution for you will depend on your personal circumstances. Seeking independent advice will ensure you make the right decisions in good time. To find a financial adviser who specialises in the LTA, use the smart search here.
About the author
Michael Roberts is a Chartered Financial Planner with Protect and Invest Ltd, a small firm based in Newbury and covering the Thames Valley. They specialise in retirement planning, investments and estate planning.
Important note: This article is for information purposes only and should not be considered to be a recommendation. This article is based on our understanding of current and draft pension and tax rules on the date of this article. Please note that tax and pension rules are subject to change; if you are at all uncertain about the suitability of any option for your circumstances you should seek regulated personal financial advice. You should not take action solely on the basis of this article without seeking advice specific to your circumstances.