Decision of a Lifetime – Allowance Reduction
The pension lifetime allowance reduction means that we need to plan carefully.
The further reduction to the pension lifetime allowance that has been proposed in the recent Budget has the feel of death by a thousand cuts for substantial pension provision. The cut from £1.25m to £1m in April 2016 will be the third in four years, leaving the allowance at less than half the level originally intended, when it was to be inflation linked from 2011/12 onwards. Proposed linking to CPI from 2018 is only limited compensation.
The proposed reduction doubles the percentage of those approaching retirement affected by the lifetime allowance from 2% to 4%, but with many more at risk in the future, particularly if escalation is scrapped or if the allowance is reduced further in years to come.
There will be some protection measures similar to those that applied from April 2014 but details on these have yet to be announced. Those who are willing to abandon future pension provision may retain the current Lifetime Allowance (Fixed Protection), with the alternative of locking in the value at April 2016 while retaining the ability to contribute in future (Individual Protection).
For some, funding fairly heavily for the next year then stopping future accrual will be appropriate. In doing that, they may be able to carry forward unused annual allowance from previous years 2015/16 or 2016/17 input periods.
Those who are aged over 55 have other options. If their pension schemes allow it, they can crystallise benefits using the current lifetime allowance and fund further in the future.
Case Study One: Defined Contribution Pension Schemes
Karen is aged 58 with defined contribution pensions totalling £937,500. She plans to work for another five years and is keen to keep funding her pension in that period. However, she is concerned that she could go over the new lifetime allowance, even if she were to stop contributing.
One option for Karen is to use a different vehicle for future savings such as ISAs and VCTs, and apply for Fixed Protection 2016 (assuming that is available on a similar basis to previously). It is likely, but not certain, that this will mean she escapes a lifetime allowance charge, and if her investments do not work out as planned she can give up protection and resume further pension contributions to make up for any shortfall.
Perhaps a better course of action, though, would be to crystallise her existing pensions, taking a 25% tax-free pension commencement lump sum (PCLS) and placing the rest in flexi-access drawdown with no income. She would use 75% of her lifetime allowance (£937,500/ £1,250,000), leaving at least £250,000 (25% of £1m) available for future contributions. That should allow her to keep contributing at a level close to the annual allowance without suffering a lifetime allowance charge. Of course, she would need to be sure that crystallising was the best thing for her, especially if she has guaranteed annuity rates or exit penalties on her existing arrangements, and since she will face another crystallisation event at age 75 she will need to keep an eye on investment growth in drawdown. She will also need to find an alternative investment for the amount taken as PCLS. But the additional funding flexibility could make it worthwhile.
Case Study Two: Defined Benefit Schemes
Similar considerations apply for Cliff, who is 57 and a member of his employer’s final salary pension. He estimates that if he takes his benefits at the normal age of 60, he will receive a pension of £60,000 a year. With a 20:1 valuation factor, this will take him over the new lifetime allowance. He could continue to accrue benefits and accept that the lifetime allowance charge will result in a pension reduction, or he could become a deferred member with Fixed Protection 2016 and forgo three years of accrual.
A third possibility allowed by Cliff’s pension scheme is to take benefits early and continue working. He again loses three years of accrual and sees his pension reduced by 15% for early retirement, leaving him with around £47,000 a year, but starting 3 years earlier. This uses up just over 75% of the current lifetime allowance. He can then join his employer’s Defined Contribution Pension Scheme and also use part of his pension income to fund heavily during the 3 years- taking a DB Pension does not trigger the money purchase annual allowance.
These case studies illustrate the potential benefits of starting to receive benefits before April 2016, even if you are still working. Individual and tax circumstances need to be taken into account, and it is certainly not the right choice for everyone.
Please do get in touch if you would like to discuss taking pension benefits or building additional pension benefits.