With the fixed protection deadline fast approaching Adrian Walker explains some less obvious considerations that advisers need to bear in mind when assessing whether their clients should apply for fixed protection.
The information below outlines a couple of areas advisers need to consider carefully when assessing their clients, especially when evaluating the benefits of switching from enhanced to fixed protection. These areas may not be immediately obvious, but can none the less make a significant difference.
Should clients with enhanced protection switch to fixed protection?
Enhanced protection secures an unrestricted lifetime allowance (LTA). This enables a pension fund to grow to amounts far exceeding the current LTA of £1.8m without incurring the 55% tax charge, making enhanced protection extremely valuable. However, unless the client has tax free cash rights exceeding £375,000 as at 6th April 2006, the maximum tax-free cash available under enhanced protection is only 25% of the prevailing LTA. With the LTA reducing from 6 April to £1.5m, clients will benefit from up to £75,000 more tax-free cash if they apply for fixed protection, and secure a LTA of £1.8m.
Switching from enhanced to fixed protection is only really viable if the projected fund at the time a client wants to take their benefits is around £1.8m. In these circumstances, clients may not fully utilise the benefit of having an unlimited LTA so may benefit more from a greater tax-fee cash entitlement. Even if someone's pension fund is expected to go slightly over £1.8m, they could still consider the benefits of switching to fixed protection. The extra they would gain in tax-free cash could greater than the 55% tax charge they would incur on receiving the amount which exceeds £1.8m as a lump sum, especially if they are a higher rate tax payer.
Those aged over 55 now could actually achieve the best of both worlds by taking some or all of their retirement savings before 6 April 2012 while the LTA is still £1.8 million. However, this will involve moving high sums of money into an environment which has a 55% tax charge if they die.
If people decide to cancel their enhanced protection and instead register for fixed protection, they create a small window of opportunity to top up their pension savings in the remainder of this tax year before the fixed protection rules kick in. They can utilise any unused annual allowances from up to three previous tax years after using up this year's annual allowance, and even invest next year's annual allowance through the clever use of pension input periods before the end of this tax year.
One final point to consider applies to those who have enhanced protection where part or all of their existing pension savings are held in a final salary pension scheme. Enhanced protection will only be valid if the value of those rights since 6th April 2006 has not increased in value, in most circumstances, by more than 5% p.a. This test only happens when a person takes their retirement benefits or transfers the cash value of those rights to a money purchase pension arrangement, so it is an unknown entity until that point in time as to whether enhanced protection will be valid. This could be a big risk to take, and people in this situation should weigh up the benefits that can be gained from having more certainty around their retirement savings, which fixed protection, could provide.
The deadline for applying to HMRC for fixed protection is 5 April, so there isn't much time left. People should send their instructions by recorded delivery to ensure it is received by the deadline as HMRC may not acknowledge all applications due to the volume of clients already registering for fixed protection.
Should clients go into drawdown now to avoid the need to apply for fixed protection?
If a client takes money out of their pension now it will free up more LTA for use going forward. This option could suit those who want to continue their pension contributions and who are considering drawdown of some funds in the near future. It works on the principle that money taken by 5 April 2012 will use up less of the person's LTA than if it is taken on or after 6 April as it is calculated as a percentage of £1.8m rather than £1.5m.
However, accessing pension money is something that should only be considered if the money is required, as any money in drawdown is subject to a 55% tax charge on death.
There are numerous factors that need to be considered to fully assess the value of the benefits someone currently holds compared to what they would have if they apply for fixed protection. Anyone with pension savings expected to reach £1.8 million should be reviewed urgently, as should anyone with enhanced protection to see what the best course of action is.
Adrian Walker is head of retirement planning at Skandia
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