Time to consider pension protection

Also featured in The Courier Business Matters Magazine on 29 September 2015

The drop in the lifetime allowance next year could affect many middle income families and will see the maximum sum that can be saved to a pension, without a tax charge, reduce to £1 million in April 2016. When the limit was at its maximum of £1.8 million in 2011/12, savers would need to have a pension income of approximately £90,000 per annum to reach this limit. The equivalent figure today is £50,000 per annum.

The change raises a host of advice issues which may need urgent attention before April. For example, considering whether additional funding is suitable, whether the tax charge should be absorbed, or whether to protect the funds already accrued.

Additional funding could maximise the level of protection available for existing pension savings. Those wishing to contribute to their pension should be aware of the annual allowance limit, especially if certain pension benefits have been accessed since April this year. This could have a major impact on how much can be paid before breaching the annual allowance and, consequently, the lifetime allowance.

The calculations required for those in a defined benefit scheme, also known as a final salary scheme, are quite complex. Many people, such as those in schemes with Universities or the NHS, will not know what they have built up for the tax year until close to 6 April. High earners may be advised to identify how close they are to breaching the annual or lifetime limits, especially if they have held a number of posts or paid additional voluntary contributions (AVCs) or free-standing additional voluntary contributions (FSAVCs).

It is not only current high earners who need to take heed. This would also apply to those who may not consider themselves close to the lifetime allowance now, but if they expect future promotions, a review may be advisable. When calculating the limit, it is the capital value of the pension at retirement that is measured against the lifetime allowance, and this may include the tax free cash sum figure if this is accrued separately.

For defined contributions plans, individuals will require current fund values and projections to their expected retirement age. The review should take into account future increases to the lifetime allowance and what fund growth is required before the limit is breached. Individuals can then consider whether making further contributions will be appropriate.

When the lifetime limit reduces next year there will be two forms of protection available to individuals who may breach £1m of pension funds. Fixed Protection 2016 will allow an individual to keep a £1.25m allowance but they will have to cease contributions. Individual Protection 2016 will provide a personal allowance (maximum £1.25m) to those with pension funds already worth more than £1m and allow further contributions. Deciding which option is best will likely require individuals to seek professional advice.

Any references to tax and legislation is based on our understanding of law and HM Revenue & Customs practice at the date of publication. Tax and legislation are liable to change. Tax relief may be altered and the value to the investor depends on their financial circumstances. The purpose of this article is to provide technical and generic guidance and should not be interpreted as a personal recommendation or advice. Investment entails risk which means the asset values can increase or decrease and you may not get back what you put in.

Contributed by Jim Wilson, Director of Henderson Loggie Financial Services Ltd, which is authorised and regulated by the Financial Conduct Authority.