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Fixed protection: stick or twist?

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Should Mindy stick or twist?

What increase in standard lifetime allowance means for clients with fixed protection

Mindy has had income for the last three tax years of around £38,000 from her tailoring alterations business.

She plans to sell the business and take her pension benefits to fund her day-to-day living expenses when she reaches her 60th birthday in August. Currently, she has no health concerns and her family history suggests she has a good chance of being fit and active well into her 80s.

Mindy is due to meet her adviser for an end of tax year review. As she holds fixed protection 2016 (FP16) her adviser knows that no more pension contributions can be made without revoking this protection. But are there some circumstances where doing so could be in the client’s best interests?

Benefit of FP16

Mindy’s retirement fund is currently £1.03m. She has the benefit of a protected lifetime allowance of £1.25m but the real value of this is only in respect of actual funds in excess of the current standard LTA of £1m.

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Assuming she crystallised all funds before 6 April, the potential LTA excess tax charge saving would be £7,500 if taking drawdown or £16,500 if she chooses a lump sum payment.

Position at 6 April

The standard LTA will increase from £1m to £1.03m from 6 April, so any immediate benefit from FP16 is diminished as crystallising the fund of £1.03m will not generate any LTA excess tax charges.

Is it worth using some pension funds now?

Mindy elects to use £500,000 now to provide pension commencement lump sum and nil income, which means the money purchase annual allowance will not apply. This means 40 per cent of the LTA is used (£500,000/£1.25m), which leaves Mindy with 60 per cent of LTA for future benefit crystallisation events.

It is important to remember that if clients have a BCE on a date when they hold valid fixed protection, this is not re-worked on the standard LTA if they subsequently lose FP16. Mindy’s next BCE will be in tax year 2018/19 and available LTA is:

60 per cent x £1.25m (using FP16) = £750,000, or

60 per cent x £1.03m (using the standard LTA) = £618,000

Mindy’s remaining pension fund is less than both of these amounts at £530,000.

Stick: should she keep FP16?

If Mindy intends to fully crystallise and drawdown at least the growth from her drawdown pot then she will not need to rely on FP16 to avoid LTA excess tax charges at age 75.

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FP16 is not providing any further benefit. It would be different if she wanted to leave it untouched for her beneficiaries. She may have wanted to retain FP16 to allow more scope at the age 75 test.

Twist: should she make more pension contributions and give up FP16?

We know Mindy will be selling her business but, before then, it could be possible to extract some profits to make a final employer contribution. As she has made no pension contributions since 5 April 2016 (a condition of FP16), after using the annual allowance for 2018/19, Mindy can carry forward unused annual allowance from 2016/17 and 2017/18. All of these years have a standard annual allowance of £40,000.

If an employer contribution of £80,000 is paid, Mindy must tell HM Revenue & Customs that FP16 has been revoked within 90 days or else she could face a fine of £300 plus £60 a day. This contribution means her pension fund is now worth £610,000 but it is all within the available lifetime allowance (60 per cent of £1.03m). This gives a total crystallised fund of £1.11m with no LTA tax charges.

Who could benefit from an LTA review?

Clients approaching retirement but who have already reached age 55, or their protected early pension age if this applies, and who have a pension fund value close to the new standard lifetime allowance limit of £1.03m.

Advisers may have clients who applied for fixed protection as they did not foresee making any future contributions but now they have a smaller fund than anticipated. This could be through poor investment returns, cautious investment choices, or perhaps they have lost a pension debit to comply with a pension sharing court order.

Earlier fixed protections (i.e. FP12 and FP14) may provide more overall benefit until the standard LTA increases further but we will need to wait for future changes in CPI rates and the actual figure to be confirmed each year.

So, stick or twist?

The correct answer will depend on each client, taking into account information such as their age, health, their pension fund size and what they intend to use their retirement fund for (i.e. spending or passing on as an inheritance). Clients with FP16 may need a pension review before the end of the current tax year due to the increase in the standard LTA from 6 April.

Jacqueline Clezy is technical specialist at Prudential

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