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Technical View

Technical View

Special Feature - Part 1


Welcome to a special edition of Technical View, which will form part of an additional series with a special focus on the April 2016 changes.

After looking at the 2016 Fixed and Individual protections being introduced alongside the reduction in the lifetime allowance, in this first part,  we will now turn our attention to highlighting circumstances in which one, both or no form of protection might be appropriate.
 

£1,800,000 to £1,000,000 in five years

 

In investment terms a near 45% fall in five years would be viewed as rather dismal. This however, is precisely the trajectory the Lifetime Allowance (LTA) will have followed when 6 April 2016 arrives bringing with it a further reduction in the allowance from £1,250,000 to £1,000,000 (it is proposed that the LTA will begin to increase in line with CPI from 2018 onwards). The LTA peak of £1,800,000 seen in 2011/12 now seems a distant memory.

As with previous reductions in the LTA the forthcoming drop to £1,000,000 brings with it two new forms of protection – Fixed Protection 2016 (FP16) and Individual Protection 2016 (IP16). This is aimed at those who had already planned their pension savings on the basis of a higher LTA so that they are not affected by the reduction in the LTA. Our Technical View issued in January 2016 examines FP16 and IP16 in greater detail but the headlines for the two new forms of protection are:-

FP16

IP16

No minimum required fund value to register Minimum fund value of £1,000,000 at 5 April 2016 required
Protected LTA of £1,250,000 Protected LTA of the 5 April 2016 fund value with upper limit of £1,250,000
No money purchase contributions after
5 April 2016
Money purchase contributions can continue
Limited defined benefit accrual after 
5 April 2016
Further defined benefit accrual allowed
Online application process available July 2016 with no deadline date Online application process available July 2016 with no deadline date


So what does this mean for clients and what options might need to be considered? We will look at a few different pre April 2016 scenarios:-

  • clients with less than £1,000,000 pension savings;
  • clients with more than £1,250,000 pension savings;
  • clients with pension savings between £1,000,000 - £1,250,000; and
  • clients in a position to crystallise pension savings ahead of April 2016.


Pension savings less than £1,000,000

 

Clients with pension savings of less than £1,000,000 will have the choice of either opting for FP16, or remaining with no protection. The starting point will be to determine what amount of pension savings an individual has as at 5 April 2016 and obtain future projections. For the purposes of this note we will assume that the client’s pension savings are in the form of uncrystallised money purchases funds but in reality they may have various pension sources including defined benefits schemes, annuities and drawdown arrangements.

As at 5 April 2016 Ian and John both have total pension savings of £750,000. Ian is looking to crystallise his benefits in four years’ time while John is looking to take benefits in eight years. Both obtain projections of their respective fund values, assuming returns of 5%pa after charges, to their chosen benefit crystallisation dates, assuming no further contributions are paid. Ian’s projected fund in four years’ time is £911,629, while John’s fund in eight years is £1,108,091. By coincidence Ian and John have the same financial adviser and each of them discusses their options with him.

Given the proximity of Ian’s anticipated retirement date his projection is likely to be more accurate than John’s. After discussing his options with his adviser they agree that FP16 is unlikely to be of benefit to him and decide not to apply for protection. By not opting for FP16 Ian is able to make further contributions, without breaching the LTA, should the anticipated returns of 5%pa be correct. In fact returns of around 7.5%pa after charges would be required before Ian’s fund hits £1,000,000 in four years’ time which, both he and his adviser consider unlikely in the current climate.

John has a more positive outlook and after discussions with his adviser they decide that the projected returns of 5%pa are achievable, which will lead to his fund in eight years exceeding £1,000,000. On this basis he elects for FP16 and is not therefore able to make further pension savings from 6 April 2016 onwards. If it is the case that the anticipated returns are not achieved and John’s fund falls below the LTA he does have the option of revoking FP16 to enable further contributions to be made. 

Determining the position for Ian and John is reasonably straightforward but what might be the position for a client that has the benefit of ongoing employer pension with no option of an alternative benefit if the pension contribution is foregone?  In some cases it can be that taxable benefit is better than receiving no benefit.

Gary has total pension savings of £800,000 and he is looking to take his benefits in four years, he receives an employer pension contribution of £20,000pa. His employer will not provide an alternative benefit to the pension contribution as part of the overall remuneration package. The position with and without an employer contribution in four years might look like:-

  With ongoing employer contribution
(paid annually in advance)
No employer contribution
Projected fund* £972,405 £972,405
Projected value of employer
contributions*
£90,512 £0
Fund available in 4 years £1,062,917 £972,405
LTA** excess £62,917 £0
Tax on excess @ 55%*** £34,604  
Net fund £1,028,313 £972,405

based on returns of 5%pa after charges    **assumes LTA remains at £1,000,000    ***where taken as a lump sum

So while continuing to receive employer contributions means Gary will exceed the LTA, the fund available to him after paying the LTA charge is £55,908 greater than it would be if he forgoes the benefit of his employer contribution demonstrating that a taxed benefit can be greater than no benefit.

Indeed it may make sense where a LTA charge arises if the excess fund above the available LTA is designated to a flexi-access drawdown fund. Instead of a 55% tax charge there would be a 25% charge deducted. Then income tax would be paid at Gary’s marginal rate when income withdrawals are taken. This may result in a lower tax charge but it will depend on Gary’s tax position when income withdrawals are taken from the flexi-access drawdown fund.

Pension savings greater than £1,250,000

 

For clients with pension savings in excess of £1,250,000 and no existing protection in place, IP16 would appear to be the way forward rather than FP16. Both IP16 and FP16 offer a protected LTA of £1,250,000 but IP16 does allow further contributions to be made which may be useful if investment returns are negative causing the fund to fall below the protected LTA.

Alan has total pension savings valued at £1,300,000 as at 5 April 2016, with no existing forms of protection in place, so opts for IP16. In March 2018 he is looking to retire and fully crystallise his fund but the value has now fallen to £1,180,000 due to a couple of years of investment turmoil and is £70,000 below his protected LTA. Luckily Alan has some spare cash available and makes a net pension contribution of £32,000 (£40,000 gross) on 31 March 2018 tested against the pension input period (PIP) ending on 5 April 2018. A new PIP opens on 6 April 2018 and Alan pays a further net contribution of £24,000 (£30,000 gross) which brings his fund up to his protected LTA of £1,250,000 at which stage he crystallises his benefits without falling foul of any LTA charge. 

Pension savings greater than £1,000,000 but not exceeding £1,250,000

 

There are choices to be made in this position and the existence of employer contributions will again be a factor. Where there are no employer contributions to consider registering for both FP16 and IP16 is an option which gives a degree of flexibility. Initially FP16 takes precedence to give a protected LTA of £1,250,000. If the client’s fund value falls FP16 could be given up leaving IP16 in place and the ability to make further contributions to bring the fund value up to the IP16 protected LTA.

As per clients with pension savings of less than £1,000,000 the position becomes a little more complicated where employer contributions are involved and no alternative benefit is on offer, if the contributions ceased, as required for FP16. Once again a starting point would be to determine the 5 April 2016 level of pension savings and obtain future projections.

Sally has total pension savings of £1,150,000 at 5 April 2016 and intends taking benefits in four years. Her employer contributes £15,000pa and offers no alternative benefit if this is given up. Her adviser considers the possible outcomes under both FP16 and IP16 and the position in four years, assuming investment returns of 5%pa are achieved, might look like:-

  FP16 no employer contributions IP16 with employer contributions
(paid annually in advance)
Projected fund* £1,397,832 £1,397,832
Projected value of employer contributions* £0 £67,884
Fund available in 4 years £1,397,832 £1,465,716
LTA** excess £147,832 £315,716
Tax on excess @ 55%*** £81,307 £173,643
Net fund £1,316,525 £1,292,073
*based on returns of 5%pa after charges    **assumes LTA remains at £1,000,000    ***where taken as a lump sum

If Sally elects for FP16 and gives up her employer contributions, her net fund after the 55% lump sum LTA charge is £24,452 greater than she would achieve under IP16 with ongoing employer contributions. Alternatively the excess fund above the available LTA could be designated to a flexi-access drawdown fund as per Gary’s example.

Elizabeth also has total pension savings of £1,150,000 but she is not looking to take to take her benefits for eight years. She too receives an employer contribution of £15,000pa with no alternative benefit on the table. Her position in eight years based on the same investment returns as Sally might look like:-
 
  FP16 no employer contributions IP16 with employer contributions
(paid annually in advance)
Projected fund* £1,699,073 £1,699,073
Projected value of employer contributions* £0 £150,398
Fund available in 4 years £1,699,073 £1,849,471
LTA** excess £449,073 £699,471
Tax on excess @ 55%*** £246,990 £384,709
Net fund £1,452,083 £1,464,762
*based on returns of 5%pa after charges    **assumes LTA remains at £1,000,000    ***where taken as a lump sum

So if Elizabeth opts for IP16 and continues to receive her employer contribution her net fund in eight years will be £12,679 greater than going down the FP16 route. Not a great return on employer contributions of £120,000 admittedly but the bottom line is that she has a slightly higher net fund. Again there is the option to designate the excess fund above the available LTA is to a flexi-access drawdown fund as per previous example.
 

So what other options might be worth considering?


For some individuals there will be the option of crystallising benefits before the 6 April 2016 LTA reduction, while others may still be able to register for IP14.
 

Taking benefits before 6 April 2016

 

Clients that have already reached the minimum pension age of 55 but have not yet crystallised benefits have the option to do so by 5 April 2016 with the crystallisation being tested against the current LTA of £1,250,000.

Rose, aged 58, has total pension savings of £900,000. If she takes her benefits now she will use up 72% of the current LTA (£900,000/£1,250,000 x 100 = 72%). In other words she will still have 28% of the then LTA available to her so scope to fund pension savings of up to £280,000 (£1,000,000 x 28%) going forward.

If Rose delays crystallisation until 6 April 2016 she will use up 90% (£900,000/£1,000,000 x 100) of the newly reduced LTA leaving a mere 10% or £100,000 available for future contributions. By crystallising benefits before 6 April 2016 the scope for future contributions is nearly three times greater.

She could of course go down the FP16 route to give her a protected LTA of £1,250,000 but this would prevent her making any further contributions.

IP14 is still available

 

It is worth remembering that it is still possible to apply for IP14 due to the 5 April 2017 deadline. This will give eligible individuals a protected LTA equal to the value of their pension savings on 5 April 2014, subject to an overall maximum of £1.5 million. To be eligible to apply for IP14 individuals must have had pension savings of at least £1,250,000 on 5 April 2014.
 
So with all these potential options on the table there is much for advisers to consider ahead of the next LTA reduction on 6 April 2016!  
If you have further queries on the content of this edition or other technical queries then please contact the Technical e-helpdesk at technical@sanlam.co.uk.

Date issued: 03.02.16

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