The problem: The client is a 55-year-old single woman with a personal pension worth £850,000 and a salary of £120,000. Her small employer currently offers no pension benefits. She would like to retire at age 65. Is fixed protection 2014 (FP14) suitable and what planning opportunities are there for the client?
The solution: The first question to be answered is in relation to the suitability of FP14.
The client’s current fund is well below the reduced lifetime allowance of £1.25m for 2014/15. However, if this is projected forward at 5 per cent p.a. to age 65 then the value would be £1,384,560. As this is over £1.25m then taking her benefits will result in a lifetime allowance charge of either 55 per cent or 25 per cent, depending on whether she takes a lump sum or income.
This results in a £33,640 tax charge if taken as an income reducing her fund to £1,350,920.
Applying for FP14 would prevent this reduction. However, there is also a planning opportunity.
The difference between the client’s projected fund and her lifetime allowance will be £115,440. Discounting this back gives a gross contribution today totalling approximately £70,000. This ensures she takes advantage of her protected lifetime allowance. But can she do this and how much does it cost?
As the proposed contribution is over the 2013/14 annual allowance of £50,000 it’s important to check there is carry forward available. As any unused carry forward from 2010/11 will be lost if not used before 5 April 2014 this is an important exercise for many clients at this time of year. In this case, assume the client does have sufficient carry forward of £20,000 available.
The cost of making this contribution should be compared against alternative investment options. What is the net cost of making this contribution? The net cost, taking into account higher rate relief and reclaiming her personal allowance (which is being lost due to the personal allowance tax trap) is £38,224.
If this lump sum were to be alternatively invested it would need to grow at 10.4 per cent p.a, before charges and after 40 per cent tax. If the client is comfortable with this hurdle rate then the alternative may provide greater flexibility for the same result. However, if it seems too high to be consistently delivered within the client’s attitude to risk, then making the pension contribution may be the best option.
Individual protection 2014 also needs to be considered. While not final at this stage, the recent near-final-draft legislation does provide enough information to have an early discussion with the client. This is essential as the application period for FP14 will have closed (5 April 2014) before applications for IP14 can begin (expected August/September 2014).
To apply for IP14 a client must have pension savings of more than £1.25m on 5 April 2014 and not hold existing primary protection. They will then have a personalised lifetime allowance equal to the value of their savings, capped at £1.5m.
With IP14 this client could gain one of two important advantages: 1) as back-up/dormant protection in the event FP14 is lost (i.e. due to auto-enrolment) or 2) the ability to continue funding the pension.
The second option, to continue funding, may be particularly attractive if and when the clients employer begins offering employer contributions. It may result in a lifetime allowance tax charge but the net benefit may still be worth it. Certainly it provides another way of demonstrating the value of advice.
Darren McAinsh is a technical manager at Prudential