As the lifetime allowance cut looms Professional Adviser finds out why fixed protection isn't right for everyone...
The number of pension savers approaching the soon-to-be-cut lifetime allowance (LTA) of £1.5m is probably higher than you might imagine. Think of all those lucky people in generous final salary schemes, for example doctors, dentists and other higher earners in the NHS.
The LTA itself is being reduced from £1.5m to £1.25m in April and as a consequence, some people with sizeable pension pots who thought they would remain within the allowance could now breach the revised cap.
A mechanism is in place to stop people falling foul of the change – applying for fixed protection at £1.5m. But is it right for everyone?
Rowanmoor Group compliance manager Mark Lisle said: "Applying for fixed protection will be the right decision for many people who have benefits close to, or more than, £1.25m. But there is a very distinct downside – all accruals in registered pension schemes must cease from 5 April 2014.
"This decision needs very careful consideration, especially for those who are still accruing generous pension benefits in final salary schemes. Breaching the LTA is not a crime and the benefits of flying in the face of the threshold may outweigh the opportunity costs."
HM Revenue & Customs cannot prevent anyone from going over the LTA. What it can do is apply a 55% tax charge if the benefits in excess are taken as a lump sum or 25% if they are taken as income.
Talbot & Muir head of technical support Claire Trott said final salary members are likely to be less aware of the impact of the LTA cut, due to the calculation needed to work out their benefits – both from the scheme and in terms of the amount set against the lifetime allowance.
She explained: "The 20 times multiple quickly adds up, to bring many closer to the lifetime allowance than they would have realised. For those in final salary schemes where there is not going to be an option of flexible benefits, such as exchanging pension contributions for another type of benefit, then remaining in the scheme and not opting for fixed protection is a very real option."
Lisle argued the additional tax charge may not be as punitive as first perceived.
"As the extra tax is only payable on the benefits over the lifetime allowance, what is there to lose, if the generosity of the final salary scheme means that the benefit will outweigh the cost? For some, accruing benefits over the lifetime allowance is still worth it," he said (see box for a practical example).
An adviser in this situation has a wide range of variables to consider – age, salary, available lifetime allowance, contribution rate, scheme benefits and normal retirement age, among others.
"However, what would appear at first glance to be a straightforward decision when it comes to protection is far from it," explained Lisle.
"The main consideration will, in all likelihood, be the ability to continue to accrue benefits for the member. This also removes concern that any pension accruing through auto-enrolment provision does not result in a loss of protection."
Trott added that many public sector schemes offer a reduced pension and/or tax free cash when the member comes to retire as a way of paying the LTA charge.
"This means that the tax charge itself will not really be felt in full for those people – which will make remaining in the scheme and paying the charge more appealing," she added.
"There is no right or wrong answer, and financial advice is essential for many that would have not considered it in the past for their pensions, due to being a member of a final salary scheme."
| CASE STUDY BOX OUT
Roger, 58, is a member of a final salary scheme with a pensionable salary of £100,000 a year. The scheme normal retirement age is 60. His expected annual pensionable salary at age 60 is £110,000. The scheme is 1/60ths, with Roger making a 5% contribution. He has exhausted his LTA.
We will assume the scheme commutation factor (which determines how any lump sum will reduce the monthly income in retirement) is 20 for a 65-year-old (this does vary between schemes).
As Roger is a higher rate tax payer, and he gets tax relief at 40%, for a year's service, the cost to Roger of his additional 5% contribution of his £100,000 pensionable salary is only £3,000, instead of £5,000.
The benefit of the enhancement over and above the lifetime allowance is 1/60 of £110,000, which equates to £1,833 per annum. In this example, let us assume that this is all taken as pension. As a result, this will incur a LTA charge of 25%.
After the LTA, the pension is the remaining 75% of £1,833 per annum, which is £1,375 per annum in this case (bear in mind this is totally dependent on the scheme commutation factor, as highlighted previously).
Remembering Roger is a 40% tax payer, the £1,375 will be reduced, after tax, to £825 per annum. But when you consider that this is £825 per annum payable from age 60, at an opportunity cost of £3,000, the fear of the LTA charge suddenly appears unfounded.
Source: Rowanmoor Group
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