From 6th April 2016, the Lifetime Allowance for pensions reduced from £1.25m to £1m. This sounds like a large figure but it can be surprisingly easy to breach what, on the face of it, seems like a very generous allowance.
In essence, the Lifetime Allowance is intended to cap the level of tax advantaged pension funds that an individual can accumulate within their lifetime. As you might imagine, a tax charge is imposed for benefits accrued in excess of the Lifetime Allowance.
It is not the first time the Lifetime Allowance (LTA) has been reduced; in April 2012 we saw it reduce from £1.8m to £1.5m, followed by a further reduction in 2014 to £1.25m. The good news, however, is that there are several forms of transitional protection available for individuals who are affected by the reduction.
How do I know if I am affected?
For individuals who only have 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 already begun to draw previously. You will need to take into account the likely fund growth and future level of pension contributions; we can do this on your behalf.
If you have benefits within a final salary pension scheme; either deferred entitlement or benefits which you are still accruing, the situation is quite different. 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, this will need to be added.
John 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 John’s employer closed the final salary scheme they have been paying into a personal pension for John, 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 John’s total pension benefit value is in excess of £1m, he will be affected by the reduction in the Lifetime Allowance. 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 and how could these help me?
There are two types of transitional protection available; Fixed Protection 2016 and Individual Protection 2016. These are described in more detail below.
Fixed Protection 2016 (FP2016)
FP2016 is available to any individual regardless of the current value of their pension benefits. In simple terms, a successful application for FP2016 will mean that you can retain the Lifetime Allowance at its current level of £1.25m, and this is the Lifetime Allowance your pension benefits will be tested against, rather than the new, lower allowance of £1m. For some individuals, this may solve the problem.
It is important to note, however, that FP2016 will be lost if future pension benefit accrual occurs, either by way of further pension contributions to a money purchase scheme or benefit accrual in a final salary scheme. Having said that, an easement exists which allows a certain level of accrual within a final salary scheme. Care must be taken to ensure you are not automatically enrolled into a workplace pension by your employer.
It is vital that no pension benefits have been accrued since 5th April 2016 as doing so would invalidate your ability to apply for FP2016.
Individual Protection 2016 (IP2016)
IP2016 is only available to individuals whose pension benefits are valued in excess of the new Lifetime Allowance of £1m as at 5th April 2016. If your pension benefits are valued at less than £1m using the valuation method explained above, this route is not available.
A successful application for IP2016 will result in a “Personalised Lifetime Allowance” (PLA) being granted. This will be based on the value of your pension benefits, 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 £1.8m, your PLA will be capped at £1.25m.
The benefit of IP2016 is that you may continue to accrue pension benefits after 5th April 2016. However it is important to consider whether it is beneficial to do so, as any future benefits accrued could well be subject to a Lifetime Allowance Charge.
Individual Protection 2014 (IP2014)
Although this type of protection relates to the previous reduction in the Lifetime Allowance which came into effect in 2014, it is still possible to apply for this type of protection until April 2017. This may be preferable depending upon the value of your pension benefits as at 5th 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, or 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 Lifetime Allowance?
As mentioned above, a tax charge, known as the Lifetime Allowance Charge is levied upon benefits in excess of the Lifetime Allowance. The amount of the charge depends on how the excess benefits are drawn; if taken as a lump sum the charge is 55%, or 25% 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 Lifetime Allowance reduction?
Individuals who feel they may be affected by the reduction in the Lifetime Allowance should seek advice as soon as possible. There is no “one size fits all” solution for individuals who are affected by the change, as it very much depends upon personal circumstances.
Is there any way to avoid the Lifetime Allowance Charge?
In short, the answer is that it depends upon your individual circumstances. There are some steps which can be taken but this is a complex area.
How do I apply for FP2016 or IP2016 Transitional Protection?
Applications for all types of transitional protection can now be made online.
This is a complex area where the right solution will depend upon each individual’s personal circumstances. As a result, it is important to seek advice to ensure you make the right decisions. To discuss your situation and how you may affected by the rules, please contact us.
This article is intended 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 as at 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 we strongly suggest you seek regulated personal financial advice. You should not take action solely on the basis of this article without seeking advice specific to your circumstances. Please get in touch to find out more.
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