Since the 2016 Budget, various changes have come into effect that could impact your clients in a number of different ways. Clare Moffat, of Prudential’s Technical team, offers some valuable insights for managing these changes and using the opportunities that arise.
Since 6 April the following changes have come into effect.
The Annual Allowance (AA) taper for higher earners will potentially reduce the maximum level of tax efficient pension contributions from £40,000 to as little as £10,000. This reduction may result in many individuals breaching the AA and suffering the resultant AA charge. This may lead to some higher earners considering if continued pension scheme membership is right for them and this will have to be an annual decision. Our Lifetime Allowance and Annual Allowance Masterclass Webexes (recordings of which are available on the PruAdviser website) explore these issues in more detail.
This issue needs to be assessed on an individual basis and while there may not be a one size fits all answer there may be a one size fits all process. In summary this process is:
This process may find out that even if there is a tax charge, continued membership of the pension may still be worth it. This could be true if the employer can’t remodel the pension and remuneration package due to the impact of the taper. Opting out of the pension scheme could mean no tax charge but it might not mean more money in the long term.
In addition, the initial impact of the tapered AA may be reduced/negated if the individual has available carry-forward, which may help with the transition, so clients will need help making sure they are taking account of all available annual allowance.
The LTA reduced from £1.25 million to £1 million on 6 April 2016. Transitional protection has been introduced as follows:
FP16 protects individuals from the LTA charge on funds up to £1.25m. Contributions and excessive accruals to all schemes had to stop before 6 April 2016 if the client wished to rely on FP16, even although the application process will not be available until July 2016 (see application process below). If the standard LTA rises to more than £1.25 million in future, the member will revert to the higher LTA. Fixed protection can be revoked in certain circumstances e.g. making contributions, excessive benefit accrual.
IP16 is very similar to Individual Protection 14 (IP14). For the new ‘Individual Protection’, clients must have had savings of at least £1m on 5 April 2016. The application process is as detailed below. Obviously the major difference between IP14 and Fixed Protection 14 (FP14) is that contributions/benefit accrual can continue under IP16.
A new online self-service protection application process will be available from July 2016. Members will no longer receive a lifetime allowance protection certificate, instead successful applicants will be provided with a reference number which they will need to keep.
HM Revenue & Customs (HMRC) have stated that there is no deadline to apply for FP16 and IP16 as long as it is applied for before benefits are crystallised on which reliance on FP16 is required. It is also worth noting that IP14 can still be applied for, up until 5 April 2017, for any clients who had over £1.25 million on 5 April 2014.
HMRC have introduced an interim process for pension scheme members who want to rely on 2016 protections, but wish to take benefits before the introduction of the new online service (see HMRC Newsletter 76). Scheme members will be able to write to HMRC between April 2016 and July 2016. HMRC will then check the details of their protection and respond to the member in writing. This can then be presented to the scheme administrator in advance of the Benefit Crystallisation Event. However, members who take advantage of the interim process will still have to make a full protection application when the online system is eventually made available. This means that unless clients really need to vest their funds, it may be best to wait until after July.
It’s also important to remember that the LTA will be indexed annually in line with Consumer Price Index from 6 April 2018.
Our December Oracle Technical article called ‘One size fits all for pension tax planning’ explores in great detail what planning considerations need to be taken into account and has some useful case studies.
The process for LTA planning is similar to that for AA as shown above. Once the process has been worked through, the relevant questions have been answered and the figures worked out, the decision about opting out of scheme membership can be made. The key point is that a tax charge is not always bad if the member ends up with more money in the long term. This is not just relevant when there is a reduction in the LTA, but it is an annual issue to deal with.
Some technical amendments will be made in the Finance Act 2016 to tidy up some areas of flexibility and make them operate as intended. Draft legislation is now out. These changes are expected to take place the day after the Bill receives Royal assent. The most noteworthy are:
From a planning point of view, the serious ill-health change means that if a client inadvertently withdraws £100 as an Uncrystallised Fund Pension Lump Sum (UFPLS) and then discovers they have a terminal illness and wants to withdraw the whole fund, it is now possible without creating new arrangements.
The post 75 tax change is also good news. But for many clients, withdrawing money from their pension fund is not going to be a good idea unless they actually need the cash to spend in their last months. If they don’t spend it and it is in their bank account on death then it has gone from a (usually) IHT friendly environment to an IHTable environment.
The age 23 change is a welcome change. Currently, a member could die with two children and the scheme administrator may decide that both should receive death benefits. However, one child is 23 in May 2016 and the other is 25. Both choose drawdown. Unless the younger child withdraws the whole fund before their 23rd birthday, then they will lose entitlement to dependant child’s drawdown and will be unable to withdraw any more money without incurring an unauthorised payment charge. The same is not true for the older child who is technically a nominee.
The proposed legislative change means that this issue will disappear as a child dependant will be able to access funds post age 23. However, this will only apply if the child dependant turns 23 on or after the day after the Bill becomes law. If you have any clients who are seriously ill and have children who are 22 and they would like them to be able to receive income benefits on their death, the only way to provide a degree of certainty is to set up a spousal bypass trust.
What will the introduction of the new LISA meant for pensions? Is it the start of the end of pensions as some have said? Who are they suitable for?
More detail on this is contained within our Oracle Technical Budget analysis. However, the high level facts are that they will be introduced from 6 April 2017 to help those between 18 and 39 (at 6/04/17), to save flexibly and tax efficiently for the long term and ensure they do not have to choose between saving for retirement and saving for their first home.
On the way in, contributions are made from post-tax income and up to £4,000 per tax year will receive the 25% bonus up to the point an individual reaches age 50 - £1,000 Government bonus for the maximum annual contribution of £4,000. This sits within the overall ISA limit. During 2017/18 tax year, only transfers from funds built up in a Help to Buy ISA before the introduction of the LISA will receive the Government bonus and will not count towards the annual LISA contribution limit. Thereafter transfers from Help to Buy ISAs will count against the annual LISA contribution limit. Help to Buy will now only be available to 30 Nov 2019 and open to contributions up to 2029.
As with ISAs, LISA will grow free of income tax and capital gains tax and it has the same investment options as regular ISA cash and investment.
On the way out funds can be withdrawn tax free if they are used to buy a first home, up to the value of £450,000, with the Government bonus, at any time from 12 months after opening the LISA account. Or withdrawals can be made tax free from age 60, with the Government bonus, for use in retirement.
Withdrawals at any time (except for terminal ill-health) for other purposes will be subject to return of the bonus element of the fund (including any interest or growth on that bonus) to the Government, and a 5% charge applied. So, individuals will have access to their savings and any interest earned on those savings minus the 5% charge. The Government will consider including other 'life events' that may allow access to funds, without charge.
The answer to this really depends on the client’s tax band and retirement income need. For those who want to buy their first home and are basic rate taxpayers then it might be better investing in a LISA. Higher rate taxpayers who will be basic rate taxpayers in retirement and don’t want to use it for house purchase, might be better using traditional pensions
It could also help those who aren’t working, as in addition to the £3,600 annual contributions into pension, they could fund a further £4,000 per tax year into a LISA giving further potential for savings. Using it in conjunction with traditional pension funding may be an option for those who are struggling with the tapered annual allowance or annual allowance.
From an IHT planning point of view, LISA could also be a very attractive to the parents and/or grandparents of young adults who wish to help them with two of the major costs of life.
This needs to be heavily caveated, as without the full details of the proposals it's difficult to draw a conclusive conclusion. However, the problem may be that LISA might not be used in conjunction with pension funding. It may be used instead of pension funding. Saving for a house could take quite a while and if all of the LISA is withdrawn there is no money left for retirement and, the nearer that house purchase is to age 50, the less years of Government contribution are left. Basic rate taxpayers may decide to opt out of occupational schemes and fund a LISA instead. From an advice point of view, advisers would need pension permissions to be able to advise on opting out of an occupational scheme to instead start a LISA. Although LISA attracts the Government contribution, individuals will lose out on the valuable employer contribution which obviously boost the fund at retirement. The contribution limits for LISA also might not provide the fund for the type of retirement that most people would like. Clients will have to wait until age 60 to withdraw any money. Also pension contributions after the age of 50 still benefit from tax relief whereas contributions to a LISA post 50 don’t benefit from the Government bonus.
It could mean that clients decide not to pay pension contributions now but instead put money into a cash ISA and then move it into LISA next year. It could also mean that parents or grandparents want to give their children or grandchildren money to be paid into a Help to Buy ISA which can then be transferred across. It may be that these are appropriate but with all types of planning decisions, it is important to run the numbers and work out each individual client situation.
The changes to AA and LTA have been known about for some time but these are issues which will need considered on an annual basis. The reduction of the LTA means that many more clients will be impacted. The taper will effect high earning clients and alternatives to pensions will need to be considered. The Budget did provide us with some good news stories in relation to a few anomalies that were in existence post freedoms but we will need to wait and see what the impact of the LISA might be, although clients might want to take action now.
Clare Moffat
Clare Moffat is a member of Prudential's Technical team, based in Craigforth, Stirling.
Clare specialises in pensions. She has a law degree and a diploma in legal practice. She qualified as a lawyer and Notary Public in September 2002 and then spent 5 years at Aegon Scottish Equitable in the legal department before moving to Pinsent Masons LLP in November 2007. While at Pinsents Clare worked for many insurance companies developing pension products, reviewing material and presenting at seminars as well as offering technical support. Clare joined the team in October 2011 and is a member of the Law Society of Scotland.
